Masters
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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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