The after-tax cost of retained earnings financing

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Reference no: EM132015220

A firm that is in the 35% tax bracket forecasts that it can retain $3 million of new earnings plans to raise new capital in the following proportions:

50% from 20-year bonds with a flotation cost of 5% of face value. Their current bonds are selling at a price of 92 (92% of face value), have 5 years remaining, have an annual coupon of 7.2%, and their investment bank thinks that new bonds will have a 50 basis point (0.50%) higher yield-to-maturity than their current 5 year bonds due to their longer term.

10% from preferred stock with a flotation cost of 6% of face value. The firm currently has an outstanding issue of $50 face value fixed-rate preferred stock with an annual dividend of $3 per share, and the stock is currently selling at $36 per share. Any newly issued preferred stock will continue with the $50 par-value, and will continue the $3 dividend.

40% from equity. Their common dividend payout ratio is 60%, they recently paid a dividend of $1.60 per share, the dividend is expected to grow to $3.50 in 10 years, and is expected to continue this growth rate into the foreseeable future. The common stock has a current market price of $19, and their investment banker suggests a flotation cost of 6% of market value on new common equity.

Part 1: The after-tax cost of the new bond financing. ___6.70%___

Part 2: The after-tax cost of the new preferred stock financing. ___9.09%___

Part 3: The after-tax cost of retained earnings financing. ___17.25%____

Part 4: Calculate the after-tax cost of the new common equity financing. ______

Part 5: Calculate the company's WACC using retained earnings as the source of equity. __________

Part 6: Calculate the break point in the cost of capital schedule due to running out of retained earnings. __________

Part 7: Calculate the company's WACC after it substitutes the new common stock issue for retained earnings after it runs out of retained earnings. _________

Part 8: Draw the cost of capital schedule for the firm. This schedule does not need to be elaborate.

Reference no: EM132015220

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