Calculate cost of debt and cost of preferred shares, Cost Accounting

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You have been asked by Mogul-Basher (MB) Ltd., a manufacturer of snowboards, to evaluate its capital structure. As a first step, you need to estimate MB's current weighted average cost of capital (WACC). You have been provided with the following information to complete this task.

MB currently has a $100 million face value long-term debt issue outstanding. The bonds have 4 years remaining until maturity, carry a 7% coupon, payable semi-annually, and have a current price of $105 per $100 face value bond. MB also has 5 million preferred shares outstanding. These shares are currently trading at $15 and carry a dividend of $1.25 per share. Finally, MB has 15 million common shares outstanding that are currently trading at $20. The beta on the common shares of MB is 1.10, the market price of risk is 6%, and the risk-free rate is 3%.

MB has been advised by its underwriters that flotation costs would be 5% after-tax on new debt and 6% before-tax on preferred shares and common shares. MB's marginal tax rate is 35%.

Required

a. Determine the appropriate weights to use in determining MB's WACC.

b. Calculate MB's cost of debt, cost of preferred shares, cost of internal equity, and cost of issuing new common equity.

c. Based on your calculations in parts (a) and (b), estimate the firm's WACC, assuming all of the required equity can be generated internally.

d. You have estimated that the firm will generate $1.5 million in internally-generated funds that are available to fund new investments. How much can the firm raise without issuing new equity, based on your previous calculations? What is the firm's marginal cost of capital (MCC) for financing required beyond this figure?


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