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Finance & Accounting

Pages 12 (3012 words)

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Topic: Finance 6

Page 1 No.1 Solution:

a. The after-tax cost of capital can be calculated by the following formula:

Kd = (I/P) (1-T)

Where, Kd = after-tax cost of debt

I = interest in dollars

P = principal amount borrowed

## Introduction

Thus from the given data, Kd = (8.5%) (1-0.30) = 5.95%

b. The cost of preferred stock is calculated by the following formula:

Kp = Dp / [Pp (1-F)]

Where, Kp = cost of preferred stock

Dp = preferred dividend

Pp= preferred stock price

F= floatation cost (Brigham & Daves, 2009, p.330).

From the data, Kp = 9/91 = 9.89%

c. Cost of common stock (at constant growing rate) can be calculated by the following formula: Ks = (D1/P0) + g

Where, Ks = cost of common stock

D1 = Dividend at the end of the first year

P0 = price of the stock at the beginning of the first year

g = growth rate (Gitman, 2007, p.448).

From the data, Ks = (0.75/15) + 0.06 = 11%

d. Calculation of Weighted Average Cost of Capital (WACC):

Capital Component Percentage of capital structure Cost Product (Percentage×Cost)

Debt 0.35 5.95% 2.08%

Preferred Stock 0.05 9.89% 0.49%

Common Stock 0.60 11% 6.60%

WACC 9.17%

Page 1 No. 2 Solution:

Cost of retained earnings (Kre) = Ke (1-f)

Where, Kre = cost of retained earnings

Ke = cost of equity

f = floatation cost (Kapil, 2011, p.278).

Ke = (2.10/34) + 0.06 = 12%

From the given data, Kre = 0.12 (1-2.38) = (16.56%) (negative)

Cost of new common stock (Kn) = (D1/Nn) + g

Where, Kn = cost of new issues of common stock

D1 = Dividend at the end of first year

Nn = net proceeds from the sale of new common stocks

g = constant growth rate (Gitman, 2007, p.448)

From the given data, Kn = (2.10/34) + 0.06 = 12.18%

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