Question

(Calculating the weighted average cost of capital) You are working as a consultant to the Lulu Athletic Clothing Company, and you have been asked to compute the appropriate discount rate to use in the evaluation of the purchase of a new warehouse facility. You have determined the market value of the firm's current capital structure (which the firm considers to be its target mix of financing sources) as follows:B To finance the purchase, Lulu will sell 20-year bonds with a $1,000 par value paying 6.4 percent per year (with interest paid semiannually) at the market price of $1,022. Preferred stock paying a $2.56 dividend can be sold for $34.87. Common stock for Lulu is currently selling for $50.64 per share. The firm paid a $3.99 dividend last year and expects dividends to continue growing at a rate of 4.4 percent per year for the indefinite future. The firm's maginal tax rate is 34 percent. What discount rate should you use to evaluate the warehouse project? a. Calculate component weights of capital. X Data Table The weight of debt in the firm's capital structure is %. (Round to two decimal places.) Source of Capital Market Values Bonds $320,000 Preferred stock $230,000 Common stock $550,000 Print Done

Answer 1

1.
=320000/(320000+230000+550000)=29.0909%

2.
=230000/(320000+230000+550000)=20.9091%

3.
=550000/(320000+230000+550000)=50.0000%

4.
Pre-tax cost of debt=RATE(20*2,6.4%*1000/2,-1022,1000)*2=6.2065%

After-tax cost of debt=6.2065%*(1-34%)=4.0963%

5.
Cost of preferred stock=2.56/34.87=7.3416%

6.
Cost of common stock=3.99*1.044/50.64+4.4%=12.6258%

7.
Discount rate=320000/(320000+230000+550000)*RATE(20*2,6.4%*1000/2,-1022,1000)*2*(1-34%)+230000/(320000+230000+550000)*2.56/34.87+550000/(320000+230000+550000)*(3.99*1.044/50.64+4.4%)=9.0396%