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Solution:: Answer: The Cost of The Preferred Stock Is 12.24%

This document contains 4 examples calculating the cost of capital for different companies. It provides the capital structure, costs of debt and equity, dividend and stock price information needed to calculate weighted average cost of capital (WACC) or cost of new common stock using standard formulas. The key information provided is the cost of capital calculated for each example, ranging from 12% WACC to 28.56% cost of new common stock.

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144 views

Solution:: Answer: The Cost of The Preferred Stock Is 12.24%

This document contains 4 examples calculating the cost of capital for different companies. It provides the capital structure, costs of debt and equity, dividend and stock price information needed to calculate weighted average cost of capital (WACC) or cost of new common stock using standard formulas. The key information provided is the cost of capital calculated for each example, ranging from 12% WACC to 28.56% cost of new common stock.

Uploaded by

Unknowingly Anonymous
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Cost of Capital

1. Sunshine Company issued preferred stocks with an underwriting cost of 2% per share. The stocks are expected to provide a
P6 dividend per share at the time of issue. They are now selling in the market for P50 each. What is the cost of the preferred
stock?

Solution:
kp = dividend ÷ ( Selling cost – flotation cost)
kp = P6 ÷ (P50 – P1) = 12.24%

Answer: The cost of the preferred stock is 12.24%.

2. Newland Company’s capital structure is as follows:

Debt 30%
Preferred stock 20%
Common equity 50%

The after-tax cost of debt is 7% percent; the cost of preferred stock is 12%; and the cost of common equity (in the form of
retained earnings) is 15%
What is the company’s weighted average cost of capital?

Solution:

Capital Composite Ratio or Weight Separate Cost of WACC


(based on capital structure) Capital
Debt 30% x 7% 2.10%
Preferred stock 20% x 12% 2.40%
Common equity 50% x 15% 7.50%
WACC 12%

Answer: The company’s weighted average cost of capital is 12%.

3. Jolly Company’s last dividend was P12.00; its growth rate is 7.5% and the stock now sells for P65. New stock can be sold to
net the firm P61.25 per share. What is the company’s cost of new common stock?

Solution:
Ke = [ ( d1 ÷ P0 – flotation costs) ] + g
= [ ( P12 x 1.075 ) ÷ P61.25 ] + .075
= 28.56%

Answer: The company’s cost of new common stock IS 28.56%.

4. DM Company is preparing to evaluate the capital expenditure proposals for the coming year. Because the firm employs
discounted cash flow methods of analyses, the cost of capital for the firm must be estimated. The following information for
the company is provided:
Market price of common stock is P80 per share.
The dividend next year is expected to be P3.10 per share.
Expected growth in dividends is a constant 10%.
New bonds can be issued at face value with a 15% coupon rate.
The current capital structure of 45% long-term debt and 55% equity is considered to be optimal.
Anticipated earnings to be retained in the coming year are P4.5 million.
The firm has a 40% marginal tax rate.

If the firm must assume a 12% flotation cost on new stock issuances, what is the cost of new common stock?

Solution:
Ke = [ ( d1 ÷ P0 – flotation costs) ] + g
= [ P3.10 ÷ ( P80 x .88 ] + .10
= 14.40%

Answer: The company’s cost of new common stock IS 14.40%.

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