Question

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P9-17 (similar to) 0 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: 35% long-term debt, 25% preferred stock, and 40% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 28%. Debt The firm can sell for $1015 a 15-year, $1,000-par-value bond paying annual interest at a 11.00% coupon rate. A flotation cost of 2% of the par value is required. Preferred stock 9.50% (annual dividend) preferred stock having a par value of $100 can be sold for $94. An additional fee of $2 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $59.43 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.70 ten years ago to the $5.07 dividend payment, Do, that the company just recently made. If the company wants to issue new new common stock, it will sell them $1.50 below the current market price to attract investors, and the company will pay $2.50 per share in flotation costs. a. Calculate the after-tax cost of debt. b. Calculate the cost of preferred stock. c. Calculate the cost of common stock (both retained earnings and new common stock). d. Calculate the WACC for Dillon Labs. a. The after-tax cost of debt using the bond's yield to maturity (YTM) is%. (Round to two decimal places.)

Answer 1

- J K 1 a.Cost of debt 2 NPER, No of period 3 Coupon rate 4 Par value 15 years 11.09 Annual 1,000 $ $ $ 995 110 2896 5 Current price,PV (1015-(Floatation cost par value) 6 PMT, periodic payments (coupon rate *par value) 7 Tax rate 8 Using Excel function 9 RATE[NPER,PMT,PV,FV) 10 After tax cost of debt YTM (ytm*(1-tax)) 11 12 b. Cost of preferred stock 13 Annual dividend (Dividend rate*par value) 14 Market price (94-additional fees) 11.07% 7.97% $ $ 9.50 92 10.33% 15 Cost of preferred stock = Annual dividend / Market price 16 17

J K $ 5.07 59.43 2.7 6.5096 15.59% 18 c). Cost of common stock 19 Do 20 Current price of stock, Po 21 Dividend 10 years ago 22 Growth rate, 23 24 Cost of retained earnings, k = (Do(1+5)/Pol+g 25 26 Cost of equity for new stock 27 Underpricing & Floatation cost 28 Current price for new common stock, po 29 30 Cost of equity of new stock k = (Do(1+g]/Pol+g 31 32 33 d) WACC using cost of retained earning 34 Particulars 35 Equity 36 Debt after tax 4 55.43 16.25% Cost Weight 15.5996 4096 7.9796 3596 Cost *weight 0.0624 0.0279 10.3396 2596 WACC 0.0258 11.6196 37 Preferred stock 38 39 40 WACC using cost of new common stock 41 Particulars 42 Equity 43 Debt after tax 44 Preferred stock 45 Cost Weight Cost * weight 16.2596 4096 0.0650 7.9796 3595 0.0279 10.3396 2596 0.0258 WACC 11.87%

J к 1 a).Cost of debt 2 NPER, No of period 3 Coupon rate 4 Par value 15 0.11 1000 years Annual = (1015-(29*1000)) -3°14 0.28 =RATE(12,36,-45,34) =J9*(1-27) 5 Current price,PV (1015-(Floatation cost par value) 6 PMT, periodic payments (coupon rate par value) 7 Tax rate 8 Using Excel function 9 RATE(NPER,PMT,PV,FV) 10 After tax cost of debt YTM (ytm*(1-tax) 11 12 b. Cost of preferred stock 13 Annual dividend (Dividend rate par value) 14 Market price (94-additional fees) Cost of preferred stock = Annual dividend / Market 15 price 16 17 -9.595 100 =94-2 =J13/114

J L — 18 c). Cost of common stock 5.07 59.43 2.7 ={(J19/321)^(1/10)-1 =(J19*(1+J22/120)+J22 19 Do 20 Current price of stock, Po 21 Dividend 10 years ago 22 Growth rate, 23 24 Cost of retained earnings, k = (Do(1+g]/Pol+g 25 26 Cost of equity for new stock 27 Underpricing & Floatation cost 28 Current price for new common stock, po 29 30 Cost of equity of new stock k = (Do(1+gl/Pol+g 31 32 33 d) WACC using cost of retained earning 34 Particulars 35 Equity 36 Debt after tax =1.5+2.5 =J20-27 =[J19*(1+J22/128)+322 Cost =J24 =J10 Weight 0.4 0.35 Cost weight -J35K35 J36K36 =J15 0.25 WACC 37*K37 =SUM(L35:L37) 37 Preferred stock 38 39 40 WACC using cost of new common stock 41 Particulars 42 Equity 43 Debt after tax 44 Preferred stock 45 Cost 30 J10 =15 Weight 0.4 0.35 0.25 WACC Cost weight =42*K42 =J43 K43 =J44 K44 =SUM(L42:L44)

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