You have been asked by Wavejumper (WJ) Ltd., a manufacturer of windsurfers, to evaluate its capital structure. As a first step, you need to estimate WJ's current weighted average cost of capital (WACC).
You have been provided with the following information to complete this task. WJ currently has a $200 million face value long-term debt issue outstanding. The bonds have 6 years remaining until maturity, carry a 12% coupon, payable semi-annually, and are priced to yield 10%. WJ also has 10 million preferred shares outstanding. These shares have a stated par value of $25, carry a 6% dividend rate, and are currently trading at $18.75. Finally, WJ has 15 million common shares outstanding, which are currently trading at $21. WJ paid a dividend of $1.25 per share on its common shares last year and investment analysts have projected these dividends to grow at an average annual rate of 3% for the foreseeable future.
WJ has been advised by its underwriters that flotation costs would be 4% after-tax on new debt and preferred shares, and 6% before-tax on common shares. WJ's marginal tax rate is 38%.
Required
a. Determine the appropriate weights to use in determining WJ's WACC.
b. Calculate WJ's cost of debt, cost of preferred shares, cost of internal equity, and cost of issuing new common equity.
c. Based on your calculations in parts (a) and (b), estimate the firm's WACC, assuming all of the required equity can be generated internally.
d. What is the firm's marginal cost of capital (MCC) if the firm needs to issue new common shares?