1. Burton currently has $850,000 of long-term debt outstanding, 5,000 shares of preferred stock ($10 par) with a market price of $12, and 20,000 shares of common stock ($20 par) with a market price of $53 per share. They have used a WACC of 14% in the past to evaluate projects but want to determine their current required return for new investments.
Debt: Burton can sell a 10-year, $1,000 par value, 7 percent annual coupon bond for $975. A flotation cost of 2 percent of the face (par) value would be required. Additionally, the firm has a marginal tax rate of 34 percent.
Preferred Stock: Burton pays $1 dividends annually on their preferred shares. The shares are currently selling for $12 in the secondary market. They do not have plans to issue any additional preferred stock.
Common Stock: Burton’s common stock is currently selling for $53 per share. The dividend expected to be paid at the end of the coming year is $4. Its dividend payments have been growing at a constant 3% rate. It is expected that to sell all the shares, a new common stock issue must be underpriced $1 per share and the firm must pay 1% of market value per share in flotation costs.
a. Calculate the after-tax cost of debt
b. Calculate the cost of preferred equity
c. Calculate the cost of common equity
d. Calculate the WACC
e. Re-calculate the NPV for the project in #1 above using this new WACC.
f. Should Burton accept the project when considering this revised cost of capital?
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