Cost of Capital

The intent of this assignment is to demonstrate proficiency in determining the costs of capital for the firm. It is a comprehensive problem in that you first need to determine the cost of each source of capital; then you need to determine the weighted average cost based on the capital structure of the firm. Lastly, you will demonstrate your understanding of marginal cost of capital, or the cost of new financing. The cost of capital of a firm will determine the profitability of projects that the firm wishes to undertake. The optimal capital structure for the firm is the one that minimizes the cost of capital, making more projects viable for the company.

Instructions

Assume the following capital structure for Ace Manufacturing Corporation:

• Debt 35%
• Preferred Stock 15%
• Common Equity 50%

The following facts are also provided:

• Bond yield to maturity 8%
• Corporate tax rate 35%
• Dividend, preferred stock $7.50
• Price, preferred stock $100
• Flotation cost, preferred stock $2
• Dividend, common stock $1.50
• Price, common stock $50
• Growth rate, common stock 5%

For this assignment, use the information above to do the following:

1. Compute the cost of the components in the capital structure.
2. Compute the weighted average cost of capital (WACC).
3. Discuss the marginal cost of capital for this firm (no calculations needed).