Problem 1 Weighted Average Cost of Capital:

Lancaster Engineering Inc (LEI) has the following capital structure, which it considers to be optimal.

Long Term Debt 25%

Preferred Stock 15%

Common Stock 60%

Total 100%

LEI can obtain capital in the following ways:

New Preferred Stock with a dividend of $11 can be sold at $97 to the public; however LEI will incur $2 of flotation costs for each share it sells.

Debt can be sold at a pre-tax cost of 12%. LEIs tax rate is 40%. (Note that 12% is the pre-tax cost; all costs must be expressed on an after-tax basis so as to be comparable.)

LEI can sell its common stock for $60. However they expect underwriting fees to be $4 per share and an additional $2 per share in other flotation costs. They expect to pay a dividend on the common stock next year of $3.60 and it is expected that dividends will continue to grow at the historical rate of 9%.

Required:

a) Determine the cost of each capital component - show how you got to your final number

b) Determine the weighted average cost of capital (WACC) for LEI - show how you got to your final number