FIN2212E Financial Management
TUTORIAL
CHAPTER: COST OF CAPITAL
1. Find the WACC using following information:
Equity = $10,000
Debt = $8,000
Cost of equity = 10%
Cost of debt before tax = 8%
Tax rate = 40%
[Answer = 7.71%]
FIN2212E Financial Management
2. Suppose that company XYZ has the following capital structure: 25 percent equity, 10
percent preferred stock, and 65 percent debt. Its marginal cost of equity is 12 percent, its
marginal cost of preferred stock is 9 percent, and its before-tax cost of debt is 7 percent. If
the marginal tax rate is 35 percent, what is company XYZ’s WACC? [Answer = 6.86%]
FIN2212E Financial Management
3. Palencia Paints Corporation has a target capital structure of 35 percent debt and 65 percent
common equity, with no preferred stock. Its before-tax cost of debt is 8 percent and its
marginal tax rate is 40 percent. The current stock price is $22.00. The last dividend
was $2.25, and it is expected to grow at a 5% constant rate. What is its cost of common
equity and its WACC? [Answer = 11.91%]
FIN2212E Financial Management
4. Hamilton Company’s 8 percent coupon rate, quarterly payment, $1,000 par value bond,
which matures in 20 years, currently sells at a price of $686.86. The company’s tax rate is
40 percent. What is the firm’s component cost of debt for purposes of calculating the
WACC? [Answer = 7.32%]
FIN2212E Financial Management
5. Paulson company's year-end balance sheet is shown below. It's cost of common equity is 14
percent, it's before-tax cost of debt is 10 percent, and its marginal tax rate is 40 percent.
Assume that the firm's long-term debt sells at par value. The firm's total debt, which is the
sum of the company's short-term and long-term debt, equals $1,167. The firm has 576
shares of common stock outstanding that sell for $4 per share. Calculate Paulson's WACC
using market-value weights. [Answer = 11.28%]
FIN2212E Financial Management
6. The capital structure for the Belton Corporation is provided below. The company plans to
maintain its debt structure in the future. If the firm has a 5.5 percent after tax cost of debt,
13.5 percent cost preferred share and 18 percent cost of common share, what is the firm’s
weighted average cost of capital? [Answer = 15.07%]
Source of capital Market Value ($)
Bonds 1,083,000
Preferred share 268,000
Common share 3,681,000
Total Capital 5,032,000
FIN2212E Financial Management
7. Crypton Electronics has a capital structurer consist of 40 percent common stock, and 60
percent debt. A debt issue of $1,000 par value, 6 percent coupon rate paying annually,
maturing in 15 years will sell for $975. Common stock of the firm is currently sell for $30 per
share. The firm expects to pay $2.25 dividend next year. Dividend has grown at the rate 5
percent per year and expected to continue to do so for the foreseeable future. Flotation cost
for the stock issue are 5 percent of market price. What is Crypton’s cost f capital where the
firm’s tax rate is 30 percent? [Answer =7.78%]
FIN2212E Financial Management
8. ALP Berhad has compiled some of the information shown in the following table.
Source of capital Market Value (RM)
Long-term debt 35,000,000
Preferred stock 10,000,000
Common stock 55,000,000
ALP Berhad just paid dividend of RM0.30 per share. The current market price per share is
RM6. Its expected growth of the dividend will be constant at 8 percent per year. Company
has to pay the underwriter fees of 6 percent to issue the common stock.
The cost of debt before tax of the company is 8 percent. Tax rate is 30 percent.
Par value of the preferred stock is RM110 per share and the annual fixed dividend rate for
the preferred stock is 10 percent. Market price of preferred stock is RM100 per stock.
Calculate the WACC of the ALP Berhad. [Answer = 10.62%]
FIN2212E Financial Management
9. Zuja Consultant Bhd. is seeking your financial advice to determine the firm’s cost of long
term financing. The following data are relevant to your task and you are required to calculate
cost of each financing.
Bond is issued at par value. The cost of debt before tax is 9 percent annually. The firm’s tax
bracket is 40 percent.
The preferred share is RM138.70 with ongoing dividend of 12 percent based on market
price. The floatation cost is 20 percent of the par value RM100.
Its common share is currently selling at RM40 per share. The last dividend paid was RM3.50
and the dividend is expected to grow at constant rate of 5 percent.
Calculate WACC if the company holds 30% of debt, 20% of common share and 50% of
preferred share on its capital. [Answer =11.47%]
FIN2212E Financial Management
10. Humble Manufacturing is interested in measuring its overall cost of capital. The firm is in the
40 percent tax bracket. Current investigation has gathered the following data:
Debt The firm can raise debt by sell bond that has 10 years’ maturity at RM970 and par
value is RM1,000. The bond pays 10 percent coupon rate and flotation costs of RM20.
Preferred Share The firm pays dividend at RM11. The share is sell at price RM100, while
the cost of issuing and selling is expected to be RM4 per share.
Common Share The firm’s common share is currently selling for RM72 per share. The firm
expects to pay cash dividends of RM6 per share next year. The firm’s dividends have been
growing at an annual rate of 6 percent.
(a) Calculate the individual cost of each source of financing. [Answer = Debt:6.30%,
Preferred: 11.46%, common:14.33%]
(b) Calculate the firm’s weighted average cost of capital using the weights shown in the
following table, which are based on the firm’s target capital structure proportions.
[Answer = 10.69%]
Sources of capital Weight (%)
Long term debt 40
Preferred share 15
Common share 45
FIN2212E Financial Management
11. Indah Corporation is considering investing in a new project and has the following capital
structure:
Source of Capital Market Value (RM)
Bond 300,000
Preferred shares 300,000
Common shares 1,400,000
Total 2,000,000
Bond
The company estimate that it can issue RM1,000 par value bonds that pay 5 percent
coupon rate and will mature in 20 years. The bond is sell at price RM980. The tax rate is 40
percent.
Preferred Shares
The company is issued preferred share at RM100 per share which pays a constant dividend
of RM3 per share. Flotation costs will be RM4 per share.
Common Shares
Currently, the common share is sell at RM80 per share. The company expected to pay
dividend of RM6 per share. It is expected to grow at a constant rate of 6 percent per year
and flotation cost will be RM8
Based on the information given, calculate:
(a) Weights for each source of capital.
(b) Cost of preferred shares.
(c) Cost of common shares.
(d) Cost of debt after tax.
(e) Weighted Average Cost of Capital (WACC). [Answer = 10.97%]
FIN2212E Financial Management
12. Nova Corporation is interested in measuring the cost of each specific type of capital as well
as the weightage average cost of capital. The firm has raise capital as the following:
Balance Sheet
Assets $ (000) Liabilities and Equities $ (000)
Cash 120 Long term debts 350
Account receivables 240 Preferred stocks 120
Inventories 280 Common stocks 530
Plant and equipment 360
Total Assets 1,000 Total Liabilities and Equities 1,000
Long-term Debts
The company sell par bond that pays 6.5 percent annual coupon interest rate with duration
of 10 years. The par value is $1,000. To sell the bonds, an average discount of $20 per
bond needs to be given. There is an associated flotation cost of 2 percent of par value. Tax
rate is 40 percent.
Preferred Shares
Preferred share has a par value of $100 per share, the annual dividend rate is 6 percent of
the par value and the flotation cost is expected to be 3.92 percent of current price. The
preferred share is expected to sell for $102 before cost consideration.
Common Shares
The current price of common shares is $35 per share. The company paid cash dividend of
$3.25 per share last years. The firm dividends have grown at annual rate of 5 percent and it
is expected that the dividend will continue at this rate for the foreseeable future. The flotation
costs are expected to be approximately 2 percent of current price.
Based on the information given, calculate:
(a) Weights of each source of capital.
(b) Cost of debt after tax.
(c) Cost of preferred shares.
(d) Cost of common shares.
(e) Weighted Average Cost of Capital (WACC). [Answer = 10.14%]
FIN2212E Financial Management
13. MajuJaya Inc. is trying to calculate its cost of capital that to be used in a capital budgeting
decision for year 2017. Mrs. Dee, the vice president of finance, has given you the following
information and has asked you to compute the weighted average cost of capital.
The common stock has a price of $20 and an expected dividend of $1.50 per share. The
firm’s growth rate of earnings and dividends per share has been 12 percent. The preferred
stock is selling at $60 per share and carries a dividend of $6.80 per share with flotation
costs at 3 percent of the selling price. The company is rated AA for the last few years and
the corporate tax rate is 40 percent. The table below shows some information for bond’s
comparative market prices of equal risk to MajuJaya Inc.:
Issues Coupon rate(5) Maturity Rating Price ($)
ABC 8 3⁄8 2020 AAA 1,120
DEF 7 1⁄2 2021 AA 825
GHI 9.66 2022 A 960
The optimum capital structure for the firm seems to be 45 percent debt, 5 percent preferred
stock, and 50 percent common equity in the form of retained earnings. [Answer = 13.68%]
FIN2212E Financial Management
14. Brook’s Window Shields Inc. is trying to calculate its cost of capital for use in capital
budgeting technique decision. Mr. Glass, the Vice-President of Finance, has given you the
following information and has asked you to compute the weightage average cost of capital.
The company currently has outstanding bond with 12.2 percent coupon rate and another
bond with 9.5 percent coupon rate. The firm has been informed by its investment banker
that bonds of equal risk and credit rating are now selling to yield 13.4 percent. The corporate
tax rate is 35 percent.
The common stock has price of $58 and expected dividend of $5.30 per share. The firm
historical growth rate of earnings and dividend per share has been 9.5 percent but security
analysist on Wall Street expect this growth to slow to 7 percent in future year.
The preferred stock is selling at $54 per share and carries dividend of $6.75 per share. The
flotation cost is 2.1 percent of selling price for preferred stock. The optimum capital structure
is 40 percent debt, 25 preferred stock and 35 percent common equity. [Answer = 12.33%]
FIN2212E Financial Management
15. Adam Corporation is considering four average-risk projects with the following possible
1rates of return:
Project Return (%)
Project A 16
Project B 15
Project C 13.75
Project D 12.50
The company estimates that it can issue debt at a rate of 10 percent, and its tax rate is 30
percent. It can issue preferred stock that pays a constant dividend of $3 per year at $40 per
share. Also, its common stock currently sells for $30 per share, the next expected dividend,
is $3.25, and the dividend is expected to grow at a constant rate of 4 percent per year. The
target capital structure consists of 75 percent common stock, 15 percent debt, and 10
percent preferred stock.
(a) What is the cost of each of the capital components?
Answer=
Debt = 7%
Preferred stock = 7.5%
Common stock = 14.83%
(b) What is Adam’s WACC? [Answer = 12.92%]
(c) Which project(s) should Adam accept? Justify.
FIN2212E Financial Management
16. Lang Enterprises is interested in measuring its overall cost of capital. Current investigation
has gathered the following data. The firm is in a 40% tax bracket.
Target Market – Source of Capital Proportions
Long-term debt 30%
Preferred stock 20%
Common stock equity 50%
Debt: The firm can raise debt by selling $1,000 par-value, 8% coupon interest rate, 20-year
bonds on which annual interest payments will be made. To sell this par bond, an average
discount of $30 per bond would have to be given to investors. The firm must also pay
flotation costs of $30 per bond.
Preferred Stock: The firm can sell 8% preferred stock at its $95 per-share value. The cost of
issuing and selling the preferred stock is expected to be $5.00 per share.
Common Stock: The firm’s common stock is currently selling for $90 per share. The firm
expects to pay cash dividends of $7.00 per share next year. The firm’s dividends have been
growing at an annual rate of 6%, and this growth is expected to continue into the future. The
stock must be underpriced by $7.00 per share, and flotation costs are expected to amount to
$5.00 per share.
Calculate the weighted average cost of capital for the Lang Enterprises assuming the firm
has exhausted all retained earnings. (That is, you must consider flotation costs for the
common stock issuance. [Answer = 10.73%]
FIN2212E Financial Management
17. Dillon Labs has asked its financial manager to measure the cost of each specific type of
capital as well as the weighted average cost of capital (WACC). The WACC is to be
measured by using the following weights: 40 percent long term debt, 10 percent preferred
stock and 50 percent common stock equity (retained earnings, new common stock, or both).
The firm's tax rate is 40 percent.
Debt - the firm can sell for $1,010 a 15-year, $1,000-par value bond paying annual interest
at a 6.00 percent coupon rate. A flotation cost of 3.5 percent of the par value is required.
Preferred stock - 9.50 percent (annual dividend) preferred stock having a par value of $100
can be sold for $98. An additional fee of $6 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 pay at the end of coming year (2020) is $4. Its dividend payments which
have been approximately 60 percent of earning per share in each of the past 5 years, were
as shown in the following table:
Year Dividend ($)
2019 3.75
2018 3.50
2017 3.30
2016 3.15
2015 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 flotation cost.
(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. [Answer = 10.85%]
FIN2212E Financial Management
18. LJS Co. faces increasing needs for capital. Fortunately, it has an AA credit rating. The
corporate tax rate is 40 percent. The firm’s financial manager is trying to determine the firm’s
current (2018) weighted average cost of capital in order to assess the profitability of capital
budgeting projects.
The company’s common stock has a price of $98.44 and a current dividend of $3.15 per
share. The par value of the common stock is $88. The historical growth pattern for dividends
is as follows:
Last year $2.81
Last 2 years $2.51
Last 3 years $2.24
Last 4 years $2.00
Last 5 years $1.93
The firm can sell the preference capital at its $10 per share par value. The dividend for the
preference share is $1.90. The cost of issuing and selling the preference capital is expected
to be 5 percent of the market price.
The table below shows the different bond issues of comparative market prices of equal risk
to LJS Co.:
Data on Bond Issues
Issues S&P’s Rating Price $
KWB Co. 8⅜ 2023 AAA 975.25
GY Co. 7½ 2028 AA 850.75
JCW Co. 9.62 2025 A 960.50
LJS Co. uses the information in the Balance Sheet, as shown in the following table, which
are based on target capital structure proportions, to calculate its weighted average cost of
capital.
Types of Capital Weight
Bond 0.20
Preferred Stock 0.15
Common Stock 0.65
Calculate the weighted average cost of capital for LJS Co. using the market value weights,
based on the information given. [Answer = 12.86%]
KTC Ltd is currently an all equity company and has an unlevered value of $100million. The
firm’s current cost of capital is 25%. Due to insufficient internal funding for KTC’s
upcoming projects the firm’s financial manager has decided to raise external funds of
$20million through debt borrowings at 10% interest rate. Its corporate tax rate is 30%.
Assume that the firm operates under the perfect capital market with corporate taxes as
argued by Modigliani and Miller. Determine KTC’s weighted average cost of capital if the
firm proceeds with raising external funds.
FIN2212E Financial Management
KTC Ltd is currently an all equity company and has an unlevered value of $100million. The
firm’s current cost of capital is 25%. Due to insufficient internal funding for KTC’s
upcoming projects the firm’s financial manager has decided to raise external funds of
$20million through debt borrowings at 10% interest rate. Its corporate tax rate is 30%.
Assume that the firm operates under the perfect capital market with corporate taxes as
argued by Modigliani and Miller. Determine KTC’s weighted average cost of capital if the
firm proceeds with raising external funds.
