2. Solving for the WACC

p2

Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $22.35 per share, and it is expected to pay a dividend of $1.36 at the end of next year. Flotation costs will represent 3% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 40%. Determine what Kuhn Companys WACC will be for this project.

3.

What do lenders require, and what kind of debt costs the company?

The cost of debt that is relevant when companies are evaluating new investment projects is the marginal cost of the new debt to be raised to finance the new project.

Consider the case of Happy Lion Manufacturing Inc. (Happy Lion):

Happy Lion Manufacturing Inc. is considering issuing a new 25-year debt issue that would pay an annual coupon payment of $95. Each bond in the issue would carry a $1,000 par value and would be expected to be sold for a price equal to its par value.

Happy Lions CFO has pointed out that the firm would incur a flotation cost of 3% when initially issuing the bond issue. Remember, the flotation costs will be _______ the proceeds the firm will receive after issuing its new bonds. The firms marginal federal-plus-state tax rate is 30%.

To see the effect of flotation costs on Happy Lions after-tax cost of debt (generic), calculate the after-tax cost of the firms debt issue with and without its flotation costs, and select the correct after-tax costs (in percentage form):

After-tax cost of debt without flotation cost:	_________
After-tax cost of debt with flotation cost:	_________

This is the cost of debt, and it is different from the average cost of capital raised in the past.