Cost of Capital - Solutions4

# Cost of Capital - Solutions4 - WACC =(3.6(0.35(10 0(0...

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Old Exam Questions - Cost of Capital - Solutions Page 11 of 42 Pages WACC = (3.6%)(0.35) + (10.0%)(0.30) + (10.71%)(0.35) = 1.26% + 3.0% + 3.7485% = 8.01% 9. A firm’s optimal capital structure consists of 35 percent debt, 5 percent preferred stock, and 60 percent common stock. Assume that the firm’s before-tax cost of debt is 7 percent and that its tax rate is 40 percent. Also assume that the firm’s cost of preferred stock is 10 percent and that its weighted average cost of capital is 10.52%. Calculate the firm’s cost of stock (equity). A. 14.50% * B. 14.25% C. 15.00% D. 14.00% E. 14.75% WACC = (K D )(1-T)(W D ) + (K P )(W P ) + (K S )(W S ) WACC = (.07)(1-.4)(.35) + (.10)(.05) + (K S )(.60) = 10.52% WACC = .0147 + .005 + (K S )(.60) = 10.52% K S = (.1052 - .0147 - .005) / (.60) = .0855 / .60 = 14.25% YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 10 - 11: Your company's current market-valued capital structure, which is considered to be optimal, is shown below: Debt 30% Preferred Stock 10% Equity 60% In order to meet their expansion plans for next year, the company has decided to raise \$10,000,000. Net Income is expected to be \$1,000,000 next year. However, preferred stock dividends are expected to account for \$100,000 of this profit. The common stock dividend payout rate is 40% of the profit after the payment of preferred dividends. The

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