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Changes in Cost and Weighted Average Cost of Capital

WACC or weighted average cost calculation 20. Carr Auto Parts is trying to calculate its cost of capital for use in a capital budgeting decision. Mr. Horn, the vice-president of finance, has given you the following information and has asked you to compute the weighted average cost of capital.

The company currently has outstanding a bond with a 12 percent coupon rate and a convertible bond with an 8.1 percent coupon rate. The firm has been informed by its investment banker, Axle, Wiell, and Axle, that bonds of equal risk and credit rating are now selling to yield 14 percent. The common stock has a price of $30 and an expected dividend (D1) of $1.30 per share. The firm's historical growth rate of earnings and dividends per share has been 15.5 percent, but security analysts on Wall Street expect this growth to slow to 12 percent in the future. The preferred stock is selling at $60 per share and carries a dividend of $6.80 per share. The corporate tax rate is 30 percent. The flotation costs are 3 percent of the selling price for preferred stock.

The optimum capital structure for the firm seems to be 45 percent debt, 5 percent preferred stock, and 55 percent common equity in the form of retained earnings.

Compute the cost of capital for the individual components in the capital structure, and then calculate the weighted average cost of capital.

Solution Preview

Please view the attachment for proper formatting of this solution.
a) Cost of debt, Kd.

As the yield to maturity is equal to 14%. Therefore, the cost of debt is 14%.

b) Cost of preferred stock, Kp.

Cost of preferred stock = Dividend/Net issuing price
= ($6.8)/($60 - ...

Solution Summary

This solution is comprised of a detailed explanation to compute the cost of capital for the individual components in the capital structure, and then calculates the weighted average cost of capital. A Word document accompanies this solution and contains the response under proper formatting.

$2.19