Longstreet Communications Inc. (LCI) has the following capital structure, which it considers to be optimal: debt = 25% (LCI has only long-term debt), preferred stock = 15%, and common stock = 60%. LCI’s tax rate is 40%, and investors expect earnings and dividends to grow at a constant rate of 6% in the future. LCI paid a dividend of $3.70 per share last year (D0), and its stock currently sells at a price of $60 per share. Ten-year Treasury bonds yield 6%, the market risk premium is 5%, and LCI’s beta is 1.3.
The following terms would apply to new security offerings.
Preferred: New preferred stock could be sold to the public at a price of $100 per share, with a dividend of $9. Flotation costs of $5 per share would be incurred. Debt: Debt could be sold at an interest rate of 9%.
Common: New common equity will be raised only by retaining earnings.
a. Find the component costs of debt, preferred stock, and common stock.
b. What is the WACC?