Question 9

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 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 semi-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 (2018) is $4. Its dividend payments, which have been approximately 60% of earnings per share in each of the past 5 years, were as shown in the following table.

YearDividend

2017$3.75

20163.50

20153.30

20143.15

20132.85

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 flotation costs. Dividend payments are expected to continue at 60% of earnings. (Assume that r_r = r_s.)

a.Calculate the after-tax cost of debt.

b.Calculate the cost of preferred stock.

c.Calculate the cost of common stock.

d.Calculate the WACC for Dillon Labs.

Question 3

Use the information below to answer the following questions

Average selling price per unit

Variable cost per unit

Units sold units

Fixed costs

Interest expense

Preference dividend

Tax

$20.00

$12.00

500,000

$1,200,000

$750,000

$420,000

30%

Required:

a)Compute the degree of operating leverage, the degree of financial leverage and the degree of combined leverage

b)If sales increase by 10%, what should happen (in terms of percentage change) to operating income (EBIT)?

c)If operating income increases by 10%, what should happen (in terms of percentage change) to EPS?

d)If sales increase by 10%, what should (in terms of percentage change) be the effect on EPS?