Question

X P9-17 (similar to) Question Help Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 50% long-term debt, 20% preferred stock, and 30% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 25%. Debt The firm can sell for $1025 a 12-year, $1,000-par-value bond paying annual interest at a 7.00% coupon rate. A flotation cost of 3% of the par value is required. Preferred stock 9.00% (annual dividend) preferred stock having a par value of $100 can be sold for $98. An additional fee of $5 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $59.43 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.00 ten years ago to the $3.42 dividend payment, Do, that the company just recently made. If the company wants to issue new new common stock, it will sell them $2.00 below the current market price to attract investors, and the company will pay $2.50 per share in flotation costs. a. Calculate the after-tax cost of debt. b. Calculate the cost of preferred stock. c. Calculate the cost of common stock (both retained earnings and new common stock). d. Calculate the WACC for Dillon Labs. a. The after-tax cost of debt using the bond's yield to maturity (YTM) is %. (Round to two decimal places.) Enter your answer in the answer box and then click Check Answer. parts Clear All Check Answer remaining

a.  The​ after-tax cost of debt using the​ bond's yield to maturity​ (YTM) is

The​ after-tax cost of debt using the approximation formula is

b.  The cost of preferred stock is

c.  The cost of retained earnings is

The cost of new common stock is

d.  Using the cost of retained​ earnings, the​ firm's WACC is

Using the cost of new common​ stock, the​ firm's WACC is

Answer 1

The​ after-tax cost of debt using the approximation formula is:-

=(70+((1000-994.25)/12))/((1000+994.25)/2)*(1-25%) =5.30%

Cost of retained earnings approach:-

Weight Cost Debt 50.00% 5.30% Preferr 20.00% 9.68% Equity 30.00% 11.58% WACC Weight*cost 2.65% 1.94% 3.48% 8.06%

Debt Preferred Equity Weight Cost Weight*cost 0.5 =RATE(12,7%*1000,-1025*97%, 1000)*(1-25%) =E4*D4 0.2 =(9%*100)/(98-5) =E5*D5 0.3 =(3.42*(1+5.5115%)/(59.43)+5.5115% =E6*D6 WACC =SUM(F4:F6)

Cost of equity approach:-

Debt Preferred Equity Weight Cost 50.00% 5.30% 20.00% 9.68% 30.00% 12.08% WACC Weight*cost 2.65% 1.94% 3.62% 8.21%

Debt Preferred Equity Weight 0.5 0.2 0.3 Cost =RATE(12,7%*1000,-1025*97%, 1000)*(1-25%) =(9%*100)/(98-5) =(3.42*(1+5.5115%)/(59.43-2-2.5)+5.5115% WACC Weight*cost =E4*D4 =E5*D5 =E6*D6 =SUM(F4:F6)

The growth rate of dividend is calculated using the RATE function as follows:-

=RATE(nper,pmt,pv,fv)

=RATE(10,,-2,3.42)

=5.115%