Cost of Capital

Question 1
Jozan Company has asked a group of financial consultants to help them determine their component
and average costs of capital. The consultants have been able to gather the following information: The
current price of the firms 40-year, RM1000 face value, 5.4% annual coupon bonds is RM1,200 with
flotation costs of 10%. The price of the firms preferred stock is RM80 but the cost of issuance is 12.5%
and pays dividends of RM7.00 per year. The common stock has a current price of RM16 per share
with flotation costs of 22.5%, expects to pay RM1.24 per share in annual dividends next year, and has
an expected annual growth rate in dividends of 20%. The market value of the sources of financing are
debt at RM5,000,000, common stock at RM1,000,000, and preferred stock at RM4,000,000. The firm is
in a 40% tax bracket.

1. What is the yield to maturity of the firms debt?

54+ (1000 1080) = 52 . = 5%

40 1040
1000 + 1080
2

2. What is the firms cost of preferred stock?

RM7.00 = 10%
RM80 RM10

3. What is the firms cost of equity?

k= RM1.24 . + 20% = 30%

(RM16.00 - RM3.60)

4. What is the firms weighted average cost of capital?

WACC = (0.5)(3.5%) + (0.1)(10%) + (0.4)(30%) = 14.75%

Question 2
Horatio Company has asked a group of financial consultants to help them determine their component
and average costs of capital. The consultants have been able to gather the following information:
i. The capital structure of the firm are 40% debt , 50% common stock and 10% preferred stock.
The firm is in a 30% tax bracket.
ii. The price of the firms preferred stock is RM30 and pays dividends of RM4.80 per annum with
flotation costs amount to 20% of market price.
iii. The current price of the firms RM1,000 par, 4-years bond, annual coupon payments of 4% is
RM900, with flotation costs of RM100 per bond.
iv. Common stock has a current price of RM15.00 per share, with flotation costs of RM0.50. The
stock expected to pay RM2.90 dividend next year. The dividends expected to have an annual
growth rate of 10%.

a) What is the firms cost of preferred stock ?

RM4.80 = 20%
RM30 RM6

b) What is the firms after-tax cost of debt?

40+ (1000 800) = 90 . = 10%

4 900
1000 + 800
2
After tax = 10% (1 0.3) = 7%

c) What is the firms cost of common stock ?

RM2.90 . + 10% = 30%
(RM15.00 0.50)

d) What is the firms weighted average cost of capital?

WACC = (0.4)(7%) + (0.1)(20%) + (0.5)(30%) = 19.80%