Company X has the following capital structure, which it considers to be optimal:

Debt =33%, Preferred stock = 28%, Common equity = 39%

Company X’s tax rate is 25% and investors expect earnings and dividends to grow at a constant rate of 6.5% in the future. Company X is expected to pay a dividend of $4.40 per share next year, and its stock currently sells at a price of $55 per share.

Company X can obtain new capital in the following ways:

Preferred: New preferred stock with a dividend of $13 can be sold to the public at a price of $109 per share.
Debt: Debt can be sold at an interest rate of 11%.

Calculate the following:

a. Cost of Common equity?

b. Cost of Preferred Equity?

c. Cost of debt?

d. Weighted Average Cost of Capital (WACC)

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anthougo anthougo · Answer 1 · 2021-11-06T21:35:22+01:00

The computations of Company X's Capital Structure is as follows:

a. Cost of Common equity = 7.48% ($4.114/$55 x 100)

b. Cost of Preferred stock = 11.93% ($13/$109 x 100)

c. After-tax cost of debt = 8.25% (11% x 1 - 0.25)

d. Weighted Average Cost of Capital (WACC):

= (39% x 7.48% + 28% x 11.93% + 33% x 8.25%)

= (2.92% + 3.34% + 2.72%)

= 8.98%

= 9%

Data and Calculations:

Capital Structure Weights:

Weight of Debt =33%

Weight of Preferred stock = 28%

Weight of Common equity = 39%

Corporate tax rate = 25%

Earnings growth = 6.5%

Expected dividend per share next year = $4.40

Dividend per share for the current year = $4.114 ($4.40 x 93.5%)

Current common stock price per share = $55

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