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Homework answers / question archive / LOFTA Corporation is interested in measuring the cost of each specific type of capital as well as the weighted average cost of capital
LOFTA Corporation is interested in measuring the cost of each specific type of capital as well as the weighted average cost of capital. Historically, the firm has raised capital in the following manner:
The tax rate of the firm is currently 30%. The needed financial information and data are as follows:
Debt LOFTA can raise debt by selling $1,000-par-value, 6.5% coupon interest rate, 10-year bonds on which annual interest payments will be made. To sell the issue, an average discount of $20 per bond needs to be given. There is an associated flotation cost of 2% of par value.
Preferred stock Preferred stock can be sold under the following terms: The security has a par value of $100 per share, the annual dividend rate is 6% of the par value, and the flotation cost is expected to be $4 per share. The preferred stock is expected to sell for $102 before cost considerations.
Common stock The current price of Nova’s common stock is $35 per share. The cash dividend is expected to be $3.25 per share next year. The firm’s dividends have grown at an annual rate of 5%, and it is expected that the dividend will continue at this rate for the foreseeable future. The flotation costs are expected to be approximately $2 per share. Nova can sell new common stock under these terms.
Retained earnings The firm 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. (Note: When measuring this cost, the firm does not concern itself with the tax bracket or brokerage fees of owners.)
TO dO
Create a spreadsheet to answer the following questions:
Calculate the after-tax cost of debt.
Calculate the cost of preferred stock.
Calculate the cost of retained earnings.
Calculate the cost of new common stock.
Calculate the firm’s weighted average cost of capital using retained earnings and the capital structure weights shown in the table above.
Calculate the firm’s weighted average cost of capital using new common stock and the capital structure weights shown in the table above...
nformation given about debt:--
Par value = 1000
Coupon rate = 6.5%
Maturity = 10 years
Discount = 20
Flotation cost = 2%
Tax rate = 21%
Coupon = 0.065 x 1000 = 65
Computing the price of the bond:--
Bond price = par value - (par value x flotation cost) - discount
=1000 - (1000 x 0.02) - 20
= 960
Cost of debt = [Int x (1 - T) + ((RV - NP) / N) ] / [ (RV + NP)/2 ]
Where,
Int = Interest amount = Interest rate x par value = 0.065 x 1000 = 65
T = tax rate = 21%
RV = Redemption value = 1000
NP = Net proceeds = 960
N = Number of years = 10 years
Therefore,
After-tax cost of debt = (65 x (1 - 0.21) ) + ((1000 - 960) / 10) / [ (1000 + 960)/2 ]
= 5.56%
Hence, the after-tax cost of debt is 5.56%.
Information given about preferrence share:--
Par Value = 100
Annaul Dividend Rate = 6%
Flotation cost = 4
Current stock price = 102
Cost of Preferred Stock = ( PD / P0 ) x 100
Where,
PD = Preferrence dividend = Annual dividend rate x par value = 0.06 x 100 = 6
P0 = Current stock price reduced by the Flotation cost = 102 - 4 = 98
Therefore,
Cost of Preferrence Stock = (6 / 98) x 100
= 6.12%
Hence, the cost of preferrence share is 6.12%.
Information given about retain earning:--
Current price (P) = 35
Expected cash Dividend (D1 ) = 3.25
Constant growth rate (G) = 5%
Flotation cost (F) = 2
Cost of Retained Earning = (D1 / P) + G
= (3.25 / 35) + 0.0.5
= 0.0929 + 0.05
= 0.1429 or 14.29%
Cost of new Common Stock = [ D1 / (P - F) ] + G
= [ 3.25 / (35 - 2) ] + 0.05
= 0.0985 + 0.05
= 0.1485 or 14.85%
