CHAPTER 9 The Cost of Capital 363 a. Calculate the weighted average cost of capital on the basis of historical market value weights. b. Calculate the weighted average cost of capital on the basis of target market value weights. C. Compare the answers obtained in parts a and b. Explain the differences. LG 4 P9-16 Cost of capital Edna Recording Studios, Inc., reported earnings available to com- LG 6 mon stock of $4,200,000 last year. From those earnings, the company paid a divi- . dend of $1.26 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 40% debt, 10% preferred stock, and 50% com- mon stock. It is taxed at a rate of 40%. a. If the market price of the common stock is $40 and dividends are expected to g sis meol done grow at a rate of 6% per year for the foreseeable future, what is the company's cost of retained earnings financing? b. If underpricing and flotation costs on new shares of common stock amount to $7.00 per share, what is the company's cost of new common stock financing? c. The company can issue $2.00 dividend preferred stock for a market price of $25.00 per share. Flotation costs would amount to $3.00 per share. What is the cost of preferred stock financing? d. The company can issue $1,000-par-value, 10% coupon, 5-year bonds that can be sold for $1,200 each. Flotation costs would amount to $25.00 per bond. Use the estimation formula to figure the approximate cost of debt financing. e. What is the WACC? 4 P9-17 Calculation of individual costs and WACC Dillon Labs has asked its financial man- ager to measure the cost of each specific type of capital as well as the weighted average 6 cost of capital. The weighted average cost is to be measured by using the following weights: 40% long-term debt, 10% preferred stock, and 50% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 40%. Debt The firm can sell for $980 a 10-year, $1,000-par-value bond paying annual interest at a 10% coupon rate. A flotation cost of 3% of the par value is required in addition to the discount of $20 per bond. Preferred stock Eight percent (annual dividend) preferred stock having a par value of $100 can be sold for $65. An additional fee of $2 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year (2016) is $4. Its