Reference no: EM132486009

A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions.

Source of Capital Target Market Proportions

Long Term Debt 25%

Preferred Stock 20%

Common Stock 55%

Debt: The firm can sell a 10-year, RM1,000 par value, 6.50 percent bond for RM960. A flotation cost of 2 percent of the face value would be required in addition to the discount of RM40.

Preferred Stock: The firm has determined it can issue preferred stock at RM71.25 per share par value. The stock will pay a RM10.50 annual dividend. The cost of issuing and selling the stock is RM3.15 per share.

Common Stock: A firm's common stock is currently selling for RM17.15 per share. The dividend expected to be paid at the end of the coming year is RM1.65. Its dividend payments have been growing at a constant rate for the last four years. Four years ago, the dividend was RM1.45. It is expected that to sell, a new common stock issue must be underpriced RM1 per share in floatation costs.

• Additionally, the firm's marginal tax rate is 35 percent.

Calculate

Question (a) The firm's before-tax and after-tax cost of debt.

Question (b) The firm's cost of preferred stock.

Question (c) The firm's cost of a new issue of common stock

Question (d) The firm's cost of retained earnings

Question (e) The weighted average cost of capital up to the point when retained earnings are exhausted.

Question (f) If the target market proportion of long-term debt is reduced to 20 percent - increasing the proportion of common stock equity to 65 percent, explain the impact to preferred stock component and the revised weighted average cost of capital.