Question

McCall Corporation has a capital structure consisting of 55 percent common equity, 30 percent debt, and 15 percent preferred stock. Any debt issues would have a pre-tax cost of 9.5%. Preferred stock can be issued for a cost of 11.5%. Common equity can be issued, but flotation costs of $4.25 per share of common stock would be paid. McCall common stock is currently selling in the market at $65 per share. McCall recently paid a dividend of $4 per share and company earnings and dividends are expected to grow at an annual rate of 8% indefinitely. McCall has a marginal tax rate of 35% and the firm wants to keep its current capital structure. If the firm needs to raise additional equity, what will be the firm's cost of capital?

Answer 1

Answer:

WACC = 12.14%

Explanation:

Cost of debt = 9.5% x (1 - 35%) = 6.175%

Cost of preferred stock = 11.5%

Cost of equity (Re) = {D₁ / [P₀(1 - F)]} + g

Re = {($4.25 x 1.08) / [$65 x (1 - $4.25/$65)]} + 8% = ($4.59 / $60.75) + 8% = 15.56%

WACC = (15.55% x 0.55) + (6.175% x 0.30) + (11.5% x 0.15) = 8.56% + 1.85% + 1.73% = 12.14%