1. ABC, Inc. is looking at raising additional capital for a future project.
The project is expected to
provide a return on investment of 13%. In order for ABC, Inc. to determine whether this project
is worth investing in, it must first determine the cost of the capital it will use to finance the
project.
a. The firm’s current stock price is $45 and it has 4 million shares of stock outstanding. The
firm also has $30 million of preferred stock and $70 million of debt. Calculate the
weights of each capital component.
b. The firm is looking at issuing a new 30-year bond that pays an annual coupon of 8% with
a flotation cost of 2%. The bond is expected to sell at its par value of $1,000. The firm’s
tax rate is 40%. Calculate the ATrd.
c. The firm will have to pay the underwriter a 10% flotation cost for the new equity it will
raise. The firm just paid out a dividend of $4.22 with an expected growth rate of 4.5%.
Calculate the re.
d. The firm expects its preferred stocks to sell for $112.55. The par value of the preferred
stock will be $100 with a 12% annual dividend. The flotation cost that will be paid to the
underwriter will be 4%. Calculate the rps.
e. Assuming that the firm’s current market value is their target capital structure, what is
the firm’s WACC?
f. Should the firm take on this investment based on the cost of the capital that it will use
to fund the project? Why?
1. Calculate the cost of debt for a firm that can issue a 15-year, 10% semiannual bond that sells for
$1,053. Assume that there are no flotation costs.
2. Calculate the cost of preferred stock for a company that can issue a perpetual preferred stock at
a price of $116 with a par value of $100 and pays an annual dividend of 12%. Assume that there
are no flotation costs.
3. Calculate the A-T Risk Premium on the preferred stock using the cost of debt in problem 1 and
the cost of preferred stock in problem 2. (Tax = 40%)
(Hint: 70% of dividend income from a preferred stock is nontaxable)
4. Calculate the cost of equity for a firm that just paid a dividend of $3.12. The firm’s current stock
price is $48 and its dividend is expected to grow at a constant rate of 6% per year. Assume that
there are no flotation costs.
5. Assume that a firm’s target capital structure is 40% in equity, 35% in debt, and 25% in preferred
stock. Calculate the WACC using the cost of debt, cost of equity, and cost of preferred stock
from the previous examples. The firm’s tax rate is 40%.
