Question
Century Distribution Company is planning a $100 million expansion of its chain of discount service stations to several neighboring parishes. This expansion will be financed
Century Distribution Company is planning a $100 million expansion of its chain of discount service stations to several neighboring parishes. This expansion will be financed as follows: Debt issued with a coupon interest rate of 15 percent. The bonds have a 10-year maturity and a $1,000 face value, and they will be sold to net Century $990 after issue costs. Century's marginal tax rate is 25 percent. 15% preferred stock having a par value of $100 can be sold for $95.00. An additional fee of $7.00 per share must be paid to the underwriters. Century's common stock pays a dividend of $2 per share. New shares can be sold to net $14 per share. Century's dividends are expected to increase at an annual rate of 5 percent for the foreseeable future. Century's capital structure is made up as follows:
Debt $20 000,000
Preferred stock 5 000,000
Common equity 75 000,000
(a) (i) Explain what is meant by the term 'cost of capital'.
(ii) Explain TWO reasons why the WACC is important to a company
(b) Calculate:
i. Cost of debt (after tax)
ii. Cost of preferred stock
iii. Cost of common stock
iv. Weighted Average Cost of capital for Century Ltd.
(c) Many factors affect a firm's cost of capital. Discuss TWO factors that lie within the control of the firm and ONE factor that is outside of the firm's control.
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