Question: Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights:40%long-term debt, 25%preferred stock, and 35%common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 25%.
Debt The firm can sell for $970 a 14-year, $1,000-par-value bond paying annual interest at a 7.00% coupon rate. A flotation cost of 4% of the par value is required in addition to the discount of $30 per bond.
Preferred stock 7.00% (annual dividend) preferred stock having a par value of $100can be sold for $65 An additional fee of $5 per share must be paid to the underwriters.
Common stock The firm's common stock is currently selling for $90 per share. The dividend expected to be paid at the end of the coming year (2016) is $3.67 Its dividend payments, which have been approximately 40% of earnings per share in the past 5 years, were as shown in the following table:
Year Dividend
2015 $3.40
2014 $3.15
2013 $2.92
2012 $2.70
2011 $2.50
It is expected that to attract buyers, new common stock must be underpriced $4
per share, and the firm must also pay $3.00
per share in flotation costs. Dividend payments are expected to continue at 40%
of earnings. (Assume that r Subscript r = r Subscript s.)
a. Calculate the after-tax cost of debt.
b. Calculate the cost of preferred stock.
c. Calculate the cost of common stock.
d. Calculate the WACC for Dillon Labs.