Question

Given the following information, calculate the weighted average cost of capital for Puppet Corporation. (Round intermediate calculations to 2 decimal places. Round the final answers to 2 decimal places.)

Percent of capital structure:
Debt	50%
Preferred stock	20
Common equity	30
Additional information:
Bond coupon rate	8.5%
Bond yield	7.25%
Bond flotation cost	2%
Dividend, expected common	$2.00
Price, common	$32.00
Dividend, preferred	6%
Flotation cost, preferred	3%
Flotation cost, common	4.50%
Corporate growth rate	7%
Corporate tax rate	35%

a. Calculate the cost of capital assuming use of internally generated funds.

Internal capital cost             %

b. Calculate the cost of capital assuming use of externally generated funds.

External capital cost             %

Answer 1

Answer:-

Cost of Debt (K_d​​​​​​) = Yield (1 - T)

K_d = 7.25%(1 - 35%)

K_d = 7.25%(0.75)

K_d = 5.44%

Cost of preferred stock (K_p​​​​​​) = dividend / (1 - Flotation cost)  

K_P = 6%(1 - 3%)

K_P = 6%(0.97)

K_P = 5.82%

Cost of equity (K_e​​​​​​) = (Expected dividend / Price) + Growth rate

K_e = ($2 /$32) + 7%

K_e = 6.25% +7% =13.25%

		Cost	Weights	Weighted Cost
Debt (Kd)		5.44%	50%	5.72
Preferred stock (Kp)		5.82%	20%	1.164
Common equity (Ke)		13.25%	30%	3.975
Weighted average cost of capital				10.889%

a) Internal Capital Cost -

K_e = (Expected dividend /Price) + growth

K_e = ($2 /$32) + 7%

K_e = 6.25% +7% =13.25%

b) External Capital Cost-

K_e ={ (Expected dividend /Price) + growth}/ (1 - Flotation cost)

K_e = {($2 /$32) + 7%}/ (1- 4.50%)

K_e = (6.25% +7%) /(0.955)

K_e =13.87%