Question
Dillon labs has asked it's financial manager to measure the cost of each specific type of capital as well as the weighted average cost of
Dillon labs has asked it's financial manager to measure the cost of each specific type of capital as well as the weighted average 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 firms tax rate is 40 %. The firm can sell its bonds for $980.00 a 10-year, 1000 par-value bond paying annual interest at a 10% coupon rate. A floatation cost of 3% of the par value is required in addition to the discount of $20 per bond. 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. The firms common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year (2010) is $ 4. It's dividend payments , which have been approximately 60% of earnings per share in each of the past five years, are shown in table below.
YEAR | DIVIDEND |
---|---|
2009 | $3.75 |
2008 | $3.50 |
2007 | $3.30 |
2006 | $3.15 |
2005 | $2.85 |
It is expected that to attract buyers, new common stock must be underpriced $5 per share, and the firm must also pay $3 per share in floatation costs. Dividend payments are expected to continue at 60% of earnings.
A. Calculate the specific cost of each source of financing. Assume that the required return of retained earnings is equal to that on common stock.
B. If earning available to common shareholders are expected to be $7 million what is the break point associated with the exhaustion of retained earnings?
C. Determine the weighted average cost of capital between zero and the break point calculated in part b.
D. Determine the weighted average cost of capital just beyond the break point calculated in part b
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