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Weighted (marginal) cost of capital

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Brick Stone, Inc., has the following capital structure:

Financing Source: Proportion of Capital Structure:
a). Debentures (9% coupon, $1,000 par value, 27%
12 year maturity)
b). Preferred stock ($2 dividend, $25 par value) 8%
c). Common Equity 65%
d). Total 100%

Brick Stone expects to raise future capital in the proportions currently indicated on the balance sheet.
The current market price for Brick Stone is $1,075. If new debentures were sold, the issuance cost would be $20 per bond.
The current market price for the preferred stock is $19. Issuance cost on new equity would be $2.50 per share.
The current market price for Brick Stone's common stock is $40.
The stock pays a current (Do) dividend of $3. This dividend is expected to grow at an annual rate of 7%.

What is the weighted (marginal) cost of capital for Brick Stone, assuming new capital is raised in the proportions shown here and that all new equity comes from the sale of new shares, new debt come from the sale of debentures, and new preferred comes from the sale of preferred stock? Interpret what this specific WACC number means to the firm and explain how it should be used by the firm. The firm's marginal tax rate is 40%.

Be sure to show all work and clearly label all variables (for example, if you use kd in an equation, explain that it represents the before-tax cost of debt). Make your final answer clear and understandable.

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Solution Summary

The solution explains the calculation of weighted (marginal) cost of capital

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Weighted marginal cost of capital

Business XYZ is interested in measuring its overall cost of capital. Assuming that the business will retain the current capital structure in the future elaborated below, what is the weighted marginal cost of capital schedule? The business is within a 34% tax bracket.

Debt: The business can raise an unlimited amount of debt by selling $1,000.00 par value, 7% coupon interest rate, 15 year bonds at which annual interest payments will be made. To sell the issue, an average discount of $25 per bond would have to be given. The business must also pay a flotation cost of $25 per bond.

Preferred Stock: The business can sell 7% preferred stock at its $90 per share par value. The floatation costs are expected to be $6 per share. An unlimited amount of preferred stock can be sold under these terms.

Common Stock: The business' common stock is currently selling for $85 per share. Last year the business paid cash dividends of $5.00 per share. The business' dividends have been growing at an annual rate of 5%, and this growth is expected to continue into the future. The stock must be underpriced by $6.00 per share, and the flotation costs are expected to be $4.00 per share. The business can sell an unlimited amount of new common stock under these terms.

Retained Earnings: The firm expects to have $110,000 of retained earnings in the coming year. Once the retained earnings are exhausted, the firm will issue new common stock.

The business' capital structure weights are as follows:
Long-Term Debt 30%
Preferred Stock 30%
Common Stock 40%

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