5. 6: The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings is used in the Dorm's WACC calculation. However, if the firm will have to issue new common stock, the cost of new common stock should be used in the firm's WACC calculation. Quantitative Problem: Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm's marginal tax rate is 25%. Assume that the firm's cost of debt, rd, is 10.6%, the firm's cost of preferred stock, fp, is 9.8% and the firm's cost of equity is 13.2% for old equity, rs, and 13.6% for new equity, re. What is the firm's weighted average cost of capital (WACC) if it uses retained earnings as its source of common equity? Do not round intermediate calculations. Round your answer to two decimal places. % What is the firm's weighted average cost of capital (WACC2) if it has to issue new common stock? Do not round intermediate calculations. Round your answer to two decimal places. % 6. 5: The Cost of Capital: Cost of New Common Stock If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected rate of return is reduced so it may not meet the firm's hurdle rate for acceptance of the project. The second approach involves adjusting the cost of common equity as follows: D Cost of equity from new stock =,= P-F +8 The difference between the flotation-adjusted cost of equity and the cost of equity calculated without the flotation adjustment represents the flotation cost adjustment. Quantitative Problem: Barton Industries expects next year's annual dividend, D, to be $2.20 and it expects dividends to grow at a constant rate g-4.3%. The firm's current common stock price, Po, is $25.00. If it needs to issue new common stock, the firm will encounter a 4.3% flotation cost, F. What is the flotation cost adjustment that must be added to its cost of retained earnings? Do not round intermediate calculations. Round your answer to two decimal places. % What is the cost of new common equity considering the estimate made from the three estimation methodologies? Do not round intermediate calculations. Round your answer to two decimal places. %