The Ewing Distribution Company (EDC) is planning a $100 million expans

QUESTION

The Ewing Distribution Company (EDC) is planning a $100 million expansion of its chain of discount service stations to several neighboring states. This expansion will be financed with debt, preferred stock and equity. The firms has 20,000 bonds with a $1,000 face value of current debt. The de
Here we have to findout the cost of debt, cost of equity and cost of preferred stock. Calculation of cost of debt: = (Interest (MV PV)/n)/(MV PV)/2 Interest is 12% on $1,000. Interest is $120 MV(maturity value of the debt is $865) n is the maturity of the bond that is 20 years.Cost of debt is = (120 (865 1000)/20)/(865 1000)/2 = (120 6.75)/932.5 = 113.25/932.5 = 0.1214 Cost of debt before taxes is 12.14% Calculation of cost of preferred stock: Cost of preferred stock = Preferred dividend/Market value of the preferred stock = $3.50/$42 = 0.833 Cost of preferred stock is 8.33%. Calculation of cost of equity: Cost of equity = Current year dividend/Net proceeds Growth rate Current year dividend is $2.10. Previous year dividend is $2 (1 g) = Current year dividend/Previous year dividend = 2.10/2 = 1.05 g = 0.05 Growth rate is 5%. Net proceeds = Mraket price Flotation costs = $15 0.1*15 = $15 $1.5 = $13.5 Cost of equity = 2.10/13.5 0.05 = 0.1556 0.05 = 0.206 Cost of equity is 20.6% Calculation of proprtion of investments: Total

value is $100,000,000Proportion of debt is = Value of debt/Total value = $20,000,000/$100,000,000 = 0.2Propotion of equiyt is = Value of equity/Total value =75,000,000/100,000,000 = 0.75Proportion of preferred stock = value of preferred stock/Total value = 5,000,000/100,000,000 = 0.05 5. Calculation of WACC: WACC = Cost of debt*(1-Taxes)*proportion of debt Cost of equity*Proportion of equity Cost of preferred stock*Proportion of preferred stock = 0.1214*(1-0.4)*0.2 0.26*0.75 0.833*0.05 = 0.02428 *0.6 0.0195 0.04165 = 0.075718 Therefore WACC is 7.57% 6. Cost of debt after taxes = Cost of debt before taxes*(1-Tax rate) = 0.1214*(1-0.4) = 0.1214*0.6 = 0.7284 Cost of debt after taxes is 7.28%

ANSWER:

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