Calculation of individual costs and WACC
Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following? weights: 50?% long-term debt, 15?% preferred? stock, and 35?% common stock equity? (retained earnings, new common? stock, or? both). The? firm's tax rate is 35?%.
Debt The firm can sell for ?$960 a 14?-year, $1,000?-par-value bond paying annual interest at a 8.00?% coupon rate. A flotation cost of 2.5?% of the par value is required in addition to the discount of $40 per bond.
Preferred stock
9.00?% (annual dividend) preferred stock having a par value of ?$100 can be sold for $75.
An additional fee of $2 per share must be paid to the underwriters.
Common stock
The? firm's common stock is currently selling for ?$70 per share. The dividend expected to be paid at the end of the coming year? (2016) is ?$3.51.
Its dividend? payments, which have been approximately 40?% of earnings per share in the past 5? years, were as shown in the following? table:
YEAR/DIVIDEND
2015 $3.34
2014 $3.18
2013 $3.03
2012 $2.89
2011 $2.75
It is expected that to attract? buyers, new common stock must be underpriced $7 per? share, and the firm must also pay $2.00 per share in flotation costs. Dividend payments are expected to continue at 40?%of earnings. ?
a. Calculate the? after-tax cost of debt.
b. Calculate the cost of preferred stock.
c. Calculate the cost of common stock.
d. Calculate the WACC for Dillon Labs.