Question

Your firm recently paid a dividend of $4 to common stockholders. Dividends are expected to grow at 8% per year for the foreseeable future. The current stock price is $54. New shares could be sold for the same price, but flotation costs would amount to $6 per share. Preferred stock would pay a 12% dividend on a $50 par value. The stocks would sell for par value less flotation costs of $2 per share. Wellington has a marginal tax rate of 34%. What is the firm's cost of capital if their capital structure consists of 60% equity and 40% preferred stock? O 11.98% O 12.58% O 13.21% 15.20% O 14.60%

Answer 1

Answer to first question in the list: Option-(d): 15.20% Workings: Cost of preferred stock = Annual preferred dividend / Current net market price per share of preferred stock Current market price per share Less: Flotation cost Current net market price per share Annual preferred dividend Cost of preferred stock $50 $2. $48 $6 ($50 x 12%] 12.5% ($6/$48 = 0.125 = 12.5%] Cost of common stock = (Next Dividend (D1) / Current market price per share) + Growth rate Current Dividend Growth rate Next Dividend (D1) Current market price per share, net Growth rate Cost of common stock $4 8% $4.32 [$4 x (1+8%) = $4 x (1+0.08) = $4 x 1.08 = $4.32] $48 ($54 - $6; net of flotation cost] 8% 17% [($4.32 / $48) + 8% = 0.09 + 8% = 9% +8% = 17%]

WACC = Sum of (Weights x Costs) 5.00% 12.5% x 40%] Weight of preferred stock 40% Cost of preferred stock 12.5% Debt's weight x cost Weight of common stock 60% Cost of common stock 17% Debt's weight x cost Weighted Average Cost of Capital (WACC) 10.20% (17% x 60%] 15.20% (5.00% + 10.20%]