Calculation of individual costs and WACC

Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has

gathered the following data. The firm is in the 40% tax bracket.

Debt

The firm can raise debt by selling $ 1,000- par- value, 8% coupon interest rate, 20- year bonds on

which annual interest payments will be made. To sell the issue, an average discount of $ 30 per

bond would have to be given. The firm also must pay flotation costs of $ 30 per bond.

Preferred stock

The firm can sell 8% preferred stock at its $ 95- per- share par value. The cost of issuing and selling

the preferred stock is expected to be $ 5 per share. Preferred stock can be sold under these terms.

Common stock

The firm's common stock is currently selling for $ 90 per share. The firm expects to pay cash

dividends of $ 7 per share next year. The firm's dividends have been growing at an annual rate of

6%, and this growth is expected to continue into the future. The stock must be underpriced by $ 7

per share, and flotation costs are expected to amount to $ 5 per share. The firm can sell new

common stock under these terms.

Retained earnings

When measuring this cost, the firm does not concern itself with the tax bracket or brokerage fees

of owners. It expects to have available $ 100,000 of retained earnings in the coming year; once

these retained earnings are exhausted, the firm will use new common stock as the form of

common stock equity financing.

a.

Calculate the after- tax cost of debt.

b.

Calculate the cost of preferred stock.

c.

Calculate the cost of common stock.

d.

Calculate the firm's weighted average cost of capital using the capital structure

weights shown in the following table.

Sources of Capital

Weight

Long term Debt

30%

Preferred Stk

20

Common Stock Equity

50

total

100%