Global Internet company is looking to expand their operations. They are evaluating their cost of capital based on various financing options. Investment bankers informed them that they can issue new debt in the form of bonds at a cost of 8%, and issue new preferred stocks for the price of $25 per share paying $2.5 dividends per share. Their common stock is currently selling for $20 per share and will pay a dividend of $1.5 per share next year. They expect a growth rate in dividends of 5% per year, and their marginal tax rate is 35%.
Requirement (b) - Cost of capital if Global raises capital using 45% debt, 5% preferred stock, and 50% common stock
After Tax Cost of Debt
After Tax Cost of Debt = Interest on Debt x [ 1 – Tax Rate]
= 8.00% x (1 – 0.35)
= 8.00% x 0.65
= 5.20%
Cost of Preferred Stock
Cost of Preferred Stock = [Annual Preferred Dividend / Selling Price] x 100
= [$2.50 / $25.00] x 100
= 10.00%
Cost of Equity
As per Discounted cash flow model, The cost of common stock = [D0(1 + g) / P0] + g
Where, Dividend in next year (D1) = $1.50 per share
Dividend growth rate (g) = 5.00% per year
Current Share Price (P0) = $20.00 per share
Therefore, cost of common stock = [D1 / P0] + g
= [$1.50 / $20.00] + 0.05
= 0.0750 + 0.05
= 0.1250 or
= 12.50%
Weighted Average Cost of Capital (WACC)
Therefore, the Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]
= [5.20% x 0.45] + [10.00% x 0.05] + [12.50% x 0.50]
= 2.34% + 0.50% + 6.25%
= 9.09%
“The Cost of capital will be 9.09%”
Requirement (b) - Cost of capital if Global raises capital using 30% debt, 5% preferred stock, and 65% common stock
After Tax Cost of Debt
After Tax Cost of Debt = Interest on Debt x [ 1 – Tax Rate]
= 8.00% x (1 – 0.35)
= 8.00% x 0.65
= 5.20%
Cost of Preferred Stock
Cost of Preferred Stock = [Annual Preferred Dividend / Selling Price] x 100
= [$2.50 / $25.00] x 100
= 10.00%
Cost of Equity
As per Discounted cash flow model, The cost of common stock = [D0(1 + g) / P0] + g
Where, Dividend in next year (D1) = $1.50 per share
Dividend growth rate (g) = 5.00% per year
Current Share Price (P0) = $20.00 per share
Therefore, cost of common stock = [D1 / P0] + g
= [$1.50 / $20.00] + 0.05
= 0.0750 + 0.05
= 0.1250 or
= 12.50%
Weighted Average Cost of Capital (WACC)
Therefore, the Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]
= [5.20% x 0.30] + [10.00% x 0.05] + [12.50% x 0.65]
= 1.56% + 0.50% + 8.13%
= 10.19%
“The Cost of capital will be 10.19%”
Global Internet company is looking to expand their operations. They are evaluating their cost of capital...
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Weighted Average Cost of Capital The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings is used in the...
Attempts: 0 Keep the Highest: 0/2 5. 6: The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new...
Back to Assignment Keep the Highest: 0/2 Attempts: 0 5. 6: The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have...