Type of financing Percentage of future financing
Bonds (8%,$1,000 par, 16 year maturity) 38%
Preferred stock (5,000 shares outstanding, 15%
$50 par, $1.50 dividend)
Common stock 47%
Total 100%

Flotation costa are (a) 15 percent of market value for new bond issue, (b) $1.21 per share for common stock, and (c) $2.01 per share for preferred stock. The dividends for common stock were $2.50 last year and are projected to have an annual growth rate of 6 percent. The firm is in a 34 percent tax bracket. What is the weighed average cost of capital if the firm finances are in the following proportions?

Market prices are $1,035 for bonds, $19 for preferred stock, and $35 for common stock. There will be sufficient internal common equity funding (i.e. retained earnings) available, such that the firm does not plan to issue new common stock.

1)
Cost of debt K d = I (1 – t) + (f – Pi) /Nm/(SV + RV)/2
I = 8% of 1000 = 80; t = 0.34; f = 15% of 1035 = 155.25
Pi = premium on issue = 1035 – 1000 = 35
N m = Term of debt = 16 years
SV = Sale value = 1035 – 155.25 = 879.75
RV = redeemable value = 1000
K d = 80 (1 – 0.34) + (155.25 – 35)/16
(1000 + 879.75)/2
= 6.42%

2)
Cost of preferred capital K p = D/SV
D = 1.50; SV = 19 – 2.01 = 16.99
K p = 1.50/16.99
= 8.83%

3)
Cost of common Stock K e = D 1 + g
P 0 – f
D 1 = 2.50 (1 + 6%) = 2.65; g = 6%; f = 1.21; P 0 = 35
K e = 2.65 + 6%
35-1.21
= 13.84%

Weighted average cost of capital:
Type of Financing Proportion of Financing Cost of capital Total cost
Bonds 38 6.42% 2.4396
Preferred stock 15 8.83% 1.3245
Common stock 47 13.84% 6.5048
Total 100 10.2689

WACC = 10.2689%

Market prices are $1,035 for bonds, $19 for preferred stock, and $35 for common stock. There will be sufficient internal common equity funding (i.e. retained earnings) available such that the firm does not plan to issue new common stock. Calculate the firm’s weighted average cost of capital.