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A firm has determined its optimal capital structure, which is composed of the following sources of financing along with target proportions to be financed using
A firm has determined its optimal capital structure, which is composed of the following sources of financing along with target proportions to be financed using each source. Source of Capital Long-term debt Preferred stock Common stock Target proportions 30% 5% 65% The firm's marginal tax rate is 21 percent. It faces the following capital market scenario: Debt: The firm can sell a 20-year, $1,000 par value, 9 percent bond for $980. Assume coupon is paid annually. A flotation cost of 2 percent of the face value would be incurred. Preferred Stock The firm has determined it can issue preferred stock at $65 per share par value. The stock will pay an $8 annual dividend. The cost of issuing and selling the stock is $3 per share. Common Stock The firm's common stock is currently selling for $40 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate of 4 per cent for the last five years, and this rate is expected to continue into the foreseeable future. It is expected that to sell, a new common stock issue must be offered at a discount of $1 per share. Additionally, the firm will incur $1 per share in flotation costs Calculate the firm's weighted average cost of capital assuming the firm has exhausted all retained earnings (10 points. 2.5 points each for each component cost and 2.5 points for WACC)
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