Collins Manufacturing Company has determined its optimal capital

Collins Manufacturing Company has determined its optimal capital structure, which is composed of the following sources and target market value proportions:

Target Market – Source of Capital Proportions

Long-term debt                   30%

Preferred stock                    10%

Common stock equity        60%

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 at a rate of 8%.

In order to assure that the new stock issuance will sell, it must be underpriced at $1 per share. In addition, the firm must pay $1 per share in flotation costs.

The firm’s tax rate is 40 percent.

Required:

Calculate the firm’ weighted average cost of capital for the Collins Company assuming the firm has exhausted all retained earnings. (That is, you must consider flotation costs for the common stock issuance.)

Here’s the SOLUTION

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