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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

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.