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Optimal Capital Structure: Calculate the WACC

Company B has a optimal capital structure with the following sources/target market ratios:

SOURCE OF CAPITAL Target Market Ratios
long term debt 30%
preferred stock 5%
commonn stock equity 65%

Debt: The firm can sell a 15 year, $1,500 par value, 10 percent bond for $1,300
A flotation cost of 2% of the face value would be required in addition to the
discount of $200

Preferred Stock: The firm issues stock at $70 per share par value. The stock will
pay a $7.00 annual dividend. The cost of issuing and selling
the stock is $4 per share

Common Stock: Common Stock is currently selling for $40 per share. The
expected dividend to be paid at the end of the year is $4.56.
The dividend 5 years ago was $2.34 and has been growing at a
constant rate ever since. It is expected that to sell, a new
common stock issue must be underpriced at $1.10 per share
and the firm must pay $1.10 per share in flotation costs. The
firm has a marginal tax rate of 35%

The firm has used up all of it's retained earnings. Calculate the firm's weighted average cost of capital

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Solution Preview

Check the attached sheet.

We have the capital structure already given in the question. What we need now to calculate the cost of debt, equity & preferred stock to arrive at WACC. In 1st part in the sheet we have calculated the before taxex cost ...

Solution Summary

The solution computes WACC for company B with given optimal capital structure.

$2.19