Balance Sheet Data

Long-Term Debt 80,000,000

Preferred Stock 20,000,000

Common Equity 20,000,000

Number of shares of Common 1,500,000 Price per share Common $42

Number of shares of Preferred 150,000 Price per share Preferred $108

Number of 8% Coupon 25-year Bonds 40,000 Price of 8% 25-year Bonds $1075

Number of 6% Coupon 15-year Bonds 40,200 Price of 6% 15-year Bonds $920

Forecasted Dividend on Common (D₁) $3.30 Dividend Rate on Preferred 9.5%

Par Value of Preferred $100 Current 10-Year Treasury Yld. 4.3%

Standard Deviation of Stock 40% Correlation Stock vs. Market 0.50

Standard Deviation of Market 15% Market Risk Premium 5.0%

Risk Premium of our Stock over our 15-yr Bonds 3.9% Forecasted Constant Growth 3.0%

Tax Rate 25% Flotation costs on Bonds 1.4%

Flotation costs on Preferred 2.4%

1. Calculate the appropriate weights to use for the financing sources. (Hint: Assume that the firm feels their current mix of long-term debt is good and would like to raise capital with the same mix of maturities)
2. Calculate the after-tax cost of debt (hint: You can account for the two bonds by taking a weighted average of their cost or by keeping them separate and putting both into the WACC formula at their individual weights). Note that there are flotation costs of 1.4% on bonds.
3. Calculate the cost of preferred. Note that there are flotation costs of 2.4% on preferred stock.
4. Calculate the cost of common (Hint: Use all three methods and take an average). Note that all common equity will come from internally generated equity (retained earnings) which means no new shares will be issued and no flotation costs incurred.
5. Calculate the WACC
6. Why are firms likely to prefer internally generated equity to issuing new shares of common? Identify and briefly explain two reasons.
7. If my firm had two separate divisions one relatively low risk and one relatively high risk, how might I apply the WACC to each division?