Individual costs and WACC Humble Manufacturing is interested in measuring its overall cost of

QUESTION

Individual costs and WACC Humble Manufacturing is interested in measuring its overall cost of capital. The firm is in the 40% tax bracket. Current investigation has gathered the following data:Debt The firm can raise debt by selling $1,000-par-value, 10% coupon interest rate, 10-year bonds on which annual interest payments will be made. To sell the issue, an average discount of $30 per bond must be given. The firm must also pay flotation costs of $20 per bond.Preferred stock The firm can sell 11% (annual dividend) preferred stock at its $100-per-share par value. The cost of issuing and selling the preferred stock is expected to be $4 per share.Common stock The firms common stock is currently selling for $80 per share. The firm expects to pay cash dividends of $6 per share next year. The firms dividends have been growing at an annual rate of 6%, and this rate is expected to continue in the future. The stock will have to be underpriced by $4 per share, and flotation costs are expected to amount to $4 per share.Retained earnings The firm expects to have $225,000 of retained earnings available in the coming year. Once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.a. Calculate the individual cost of each source of financing. (Round to the nearest 0.1%.)b. Calculate the firms weighted average cost of capital using the weights shown in the following table, which are based on the firms target capital structure proportions. (Round to the nearest 0.1%.)Source of capitalWeightLong-term debt40%Preferred stock15Common stock equity45Total100%
Answer A Cost of Debt = [Interest add (par value less discount less floatation cost)/n]/[Par Value less discount less floatation cost add Par Value/2] Cost of Debt = 10% of $ 1,000 add ($ 1,000 less ($ 1,000 less $ 30 less $ 20)/10/$ 950 add $ 1,000/2 Cost of Debt = $ 100 add $ 50/10/$ 1,950/2 Cost of Debt = 10.80 % After tax cost of debt = 10.80% (1-0.40) = 6.46 % Cost of preferred stock = Dividend/Net Proceeds Cost of preferred stock = $ 11/$

0 less $ 4 = 11.45 % Cost of common stock = Next Dividend/Current price add growth rate Cost of common stock = $ 6/$ 80 add 6% = 13.50 % Answer B Source of Capital Cost of Capital Weight WACC Long term debt 6.46% 0.4 2.58% Preferred stock 11.46% 0.15 1.72% Common Stock 13.50% 0.45 6.08% Total 10.38%

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