Determine the cost of each capital component

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Reference no: EM131622909

Lancaster Engineering Inc (LEI) has the following capital structure, which it considers to be optimal.

Long Term Debt 30%

Preferred Stock 10%

Common Stock 60%

Total 100%

LEI can obtain capital in the following ways:

New Preferred Stock with a dividend of $12 can be sold at $97 to the public; however LEI will incur $2 of flotation costs for each share it sells.

Debt can be sold at a pre-tax cost of 12%. LEI’s tax rate is 40%. (Note that 12% is the pre-tax cost; all costs must be expressed on an after-tax basis so as to be comparable.)

LEI can sell its common stock for $55. However they expect underwriting fees to be $3 per share and an additional $2 per share in other flotation costs. They expect to pay a dividend on the common stock next year of $3.50 and it is expected that dividends will continue to grow at the historical rate of 8%.

Required:

Determine the cost of each capital component.

Determine the weighted average cost of capital (WACC) for LEI.

Reference no: EM131622909

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