A Firm Has Determined Its Optimal Capital Structure, Which Is

question 59

Essay

A firm has determined its optimal capital structure, which is composed of the following sources and target market value proportions: Debt: The firm can sell a 20-year, $1,000 par value, 9 percent bond for $980. A flotation cost of 2 percent of the face value would be required in addition to the discount of $20.
Preferred Stock: The firm has determined it can issue preferred stock at $65 per share par value. The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is $3 per share.
Common Stock: The firm's common stock is currently selling for $40 per share. The dividend expected to be paid at the end of the coming year is $5.07. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.45. It is expected that to sell, a new common stock issue must be underpriced at $1 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm's marginal tax rate is 40 percent.
Calculate the firm's weighted average cost of capital assuming the firm has exhausted all retained earnings.

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Definitions:

Blu-ray Players

Devices designed to play Blu-ray discs, which are used for storing and viewing high-definition video and data.

Trade Discount

A reduction on the list price granted by a seller to a buyer based on the volume of the transaction or the buyer's trade status.

Power Saw

A mechanical tool used for cutting through materials like wood, metal, or plastic with a sharp, toothed blade that moves rapidly.

Net Price

The price of a good or service after all discounts, rebates, and allowances have been subtracted from the gross price.