Question

Edna Recording​ Studios, Inc., reported earnings available to common stock of ​$4 comma 200 comma 0004,200,000 last year. From those​ earnings, the company paid a dividend of ​$1.261.26 on each of its 1 comma 000 comma 0001,000,000 common shares outstanding. The capital structure of the company includes 4040​% ​debt, 1010​% preferred​ stock, and 5050​% common stock. It is taxed at a rate of 2121​%. a. If the market price of the common stock is $40 and divendends are expected to grow at a rate of 6% per year for the forseeable future, what is the company's cost of retained earnings financing?

b. If underpricing and floatation costs on new shares of common stock amount to $7.00 per share, what is the company's cost of new common stock financing?

c. The company can issue $2.00 dividend preferred stock for a market price of $25.00 per share. Flotation costs would amount to $3.00 per share. What is the cost of perferred stock financing?

d. The company can issue $1,000-par-value, 10% coupon, 5-year bonds that can be sold for $1,200 each. Floatation costs would amount to $25.00 per bond. Use the estimation formula to figure the approximate cost of debt financing.

e. What is the WACC?

Answer 1

Check the following calculations

Step-by-step explanation:

a. Cost of Retained Earnings(Ke) = [Dividend (1+growth)/Market price] + growth Cost of Retained Earnings

=[1.26 (1+0.06)/40] + 0.06

=0.09339

=9.339%

=9.34%

b. Company Cost of New Common Stock

(Ks)=[Dividend (1+growth)/(Market price - floatation costs ] + growth Rate

=[1.26 (1+0.06)/(40-7)]+0.06

=0.10047

=10.047%

=10%

c. Cost of Preferred Stock

Kp=Prefered Dividend/(market price - Flotation cost)

=2/(25-3)

=0.090909

=9.09%

d. cost of debt financing

Kd= [{Coupon +(FV-RV)/T}/(FV+RV)/2] x [1 - 0.40]

=[{100+(1000-1175)/5}/(1000+1175)/2] x [1-0.40]

=[65/1087.5] x 0.60

=0.035862

=3.586%

=3.59%

e. WACC

The maximum investment that Edna Recording Studios can make in new projects before it must issue new common stock

And maintaining the same capital structure

total capital fund before raised

that is out [4,200,000 - 1000,000 x 1.26] / 0.5 =$5,880,000

I WACC for the project that are finance from old fund

WACC= Ke x E/V +Kp x P/V + Kd x D/V

= 9.339 x 0.50 + 9.09 x 0.10 + 3.586 x 0.4

=7.0129% [this wacc is for procets finance from 0 to $5,880,000 FUND]

II WACC for the project that is financed from revised raised fund above $5,880,000. Assuming fund is raised from all the three sources like that maintain same ratio of capital structure means percentage of fund in the capital structure

WACC= Ke x E/V +Kp x P/V + Kd x D/V

= 10.047 x 0.50 + 9.09 x 0.10 + 3.586 x 0.4

=7.3669% [this wacc is for the projects from above $5,880,000]

Kp=Cost of preferred stock

Ke = cost of equity

Kd = cost of debt

D = market value of the firm’s debt

V = E + D+P

E/V = percentage of financing that is equity = 50%

D/V = percentage of financing that is debt=40%

P/V=Percentage of financing that is preferred stock=10%