ACT172: Cost of Capital (Sample Problems)

1. If XYZ Corporation can borrow at an interest rate of 12% and the effective tax rate is 25%, its
after-tax cost of debt will be ___________

2. ABC Company plans to sell preferred share for its par value of P25.00 per share. The issue is
expected to pay quarterly dividends of P0.60 per share and to have flotation costs of 1.50. The
cost of new preferred share is:

3. (CAPM) ABC Company’s ordinary equity shares sell for P32.75 per share. ABC expects to set their
next annual dividend at P1.54 Per share. If ABC expects future dividends to grow by 6% per year,
indefinitely, the current-risk-free rate is 3%, the expected return on the market is 9%, and the
stock has a beta of 1.3, what should the firm’s cost of equity be?

4. LMNOP Company’s long-term bond rate is 9.5% percent. The firm’s management estimates that
its cost of equity should require a 3 percentage point risk premium above the cost of its own
bonds. Using the generalized risk premium approach, the cost of equity would be?

5. (Cost of RE) A company requires an 8% minimum rate of return and will pay a P3 dividend per
share next year, which is expected to increase by 5% annually. Thus, the company’s stock sells
at?

6. (Cost of new common stock issued) GHI Company’s ordinary equity share has a current market
price of P45.00 and an expected dividend growth rate of 5%. The firm is expected to pay P3.60
per share in ordinary equity share dividends during the next year. The sale of new ordinary
equity share involves underpricing of P1.00 per share and underwriting fee of P0.80 per share.
What is the cost of the new ordinary equity share?

7. The following data are available for CDE Company.

Source of Capital Existing Capital Structure Specific Cost

based on Book Value (%)

Amount Proportion

Bonds (P1,000 par, 9.5% coupon) P15, 000,000 30% 6.60

Preferred share (200,000 shares at P25 par) 5,000,000 10% 10.21

Ordinary equity shares (1,000,000 shares at 20,000,000 40% 13.33

P20 par)

Retained Earnings 10,000,000 20% 13

Total P50,000,000 100%

I. Determine the WACC if the firm obtains new capital in Book Value Proportions

II. In addition to the data provided in (I.), assume that the security market prices of CDE
Company are:
 Bonds = P980 per bond

Preferred shares = P25 per share

Ordinary equity shares = P45 per share

Determine the WACC if the firm obtains new capital in Market Value Proportions

III. In addition to the data provided in (I.) and (II.), CDE Company has determined that its optimal
capital structure is as follows:

Bonds 40%

Preferred shares 10

Ordinary equity shares 50

100%

The firm wants to maintain its optimal capital structure increasing future long-term capital. The firm
also expects to have sufficient retained earnings so that it can use the cost of retained earnings as
the ordinary equity cost component. If CDE Company raises new capital in target proportions, the
firm’s WACC can be computed as follows: