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Homework Problem
Cost of Capital
The following balance sheet reflects market values of the target proportions of Firm A’s capital
structure.
Assets $256,334
Debt
$ 87,154
Pref Stk
$ 25,633
Com. Stk
$143,547
Firm A plans to finance the planned projects from the following sources:
Debt: Existing bonds of similar risk and maturity have an annual coupon of 6.5 percent, paid
semiannually, mature in 10 years, and currently sell for $987.45. The firm’s marginal tax rate is
34%.
Preferred Stock: The firm plans to issue 10% preferred stock with a par value of $30. The
shares are expected to sell for $40.
Common Stock: The firm will issue new shares to provide the common stock portion of
financing. The most recent dividend, D0 was $2.85 and that dividend is expected to grow at 2.5
percent per year. The current share price is $45.80. (Hint: Use the dividend discount model (p.
10 in the PP slides) to estimate the cost of common stock. D1 = D0(1 + g)).
Using this information, estimate Firm A’s weighted average cost of capital. Show all
calculations for the weights, the component costs of capital, and the WACC (interim results for
component costs in percent to three decimal places and cost of capital to two decimal places,
(e.g. KP = 6.352%, WACC = 8.25%) . For the cost of debt, list all the keystrokes and values
input to the financial calculator, e.g. PV = xxxx, PMT = yyy, etc. Do all calculations on this
sheet in pencil.
Check Answers: WD = 0.34, WP = 0.10, WE = 0.56, KD = 6.660%, KP = 7.500%, KE = 8.878%
WACC = 7.22%
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