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# Company B: Cost of Retained earnings, cost of debt, current WACC

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Company B estimates that it can issue debt at a before-tax cost of 12%, and its tax rate is 35%. The company can also issue preferred stock at \$30 per share, which pays a constant dividend of \$5 annually. Floatation costs on the preferred are \$1 per share.

Net income is estimated to be \$200,000, and the firm plans to maintain its policy of paying out 30% as dividends. The company's stock currently sells for \$36 per share. The next dividend is expected to be \$2.35, which is \$.15 higher than the most recent dividend. Furthermore, these dividends are expected to continue to grow at the same rate. Float costs on newly issued common stock are \$3 per share. The company's balance sheet is financed with optimal proportions of debt and equity and is as follows:

PP&E \$250,000 Debt \$250,000
Cash \$100,000 Preferred Stock \$ ?
Inventories \$300,000 Common Equity \$300,000
Total Assets \$650,000 Total Liab. \$ ?

1. What is the cost of retained earnings? Should be expressed in a %age.

2. What is the relevant cost of debt (%age)? Should be expressed in a %age.

3. What is Company B's current WACC? Should be expressed in a %age.

#### Solution Preview

PP&E \$250,000 Debt \$250,000
Cash \$100,000 Preferred Stock \$100,000
Inventories \$300,000 Common Equity \$300,000
Total Assets \$650,000 Total Liab.+Equity \$ 650,000

1. ...

#### Solution Summary

The solution displays all the formulas and calculations to arrive at the answers to the problems.

\$2.49