Chapter 9, Problem 9.16P

Cost of capital Edna Recording Studios Inc. reported earnings available to common stock of $4,200,000 last year. From those earnings, the company paid a dividend of $1.26 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 40% debt, 10% preferred stock, and 50% common stock. It is taxed at a rate of 40%.

1. a. If the market price of the common stock is $40 and dividends are expected to grow at a rate of 6% per year for the foreseeable future, what is the required return on the company’s common stock, and thus the company’s cost of retained earnings financing?
2. b. If underpricing and flotation costs on new shares of common stock amount to $7.00 per share, what is the company’s cost of new common stock financing?
3. c. The company can issue a $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 preferred stock financing?
4. d. The company can issue $1,000-par-vatue, 10% coupon, 5-year bonds that can be sold for $1,200 each. Flotation costs would amount to $25.00 per bond. Use the estimation formula to figure the approximate cost of debt financing.
5. e. What is the WACC?