ABC, Inc. is interested in measuring its overall cost of capital and has gathered the following data. Under the terms described below, the company can sell unlimited amounts of all instruments.
- ABC can raise cash by selling $1,000, 8 percent, 20-year bonds with annual interest payments.
In selling the issue, an average premium of $30 per bond would be received, and the firm must pay floatation costs of $30 per bond. The after-tax cost of funds is estimated to be 4.8 percent.
- ABC can sell 8 percent preferred stock at par value, $105 per share. The cost of issuing and selling the
preferred stock is expected to be $5 per share.
- ABC' common stock is currently selling for $100 per share. The firm expects to pay cash dividends of $7
per share next year, and the dividends are expected to remain constant. The stock will have to be underpriced by $3 per share, and floatation costs are expected to amount to $5 per share.
- ABC expects to have available $100,000 of retained earnings in the coming year; once these retained
earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.
- ABC' preferred capital structure is:
Long-term debt 30%
Preferred stock 20
Common stock 50
The cost of funds from retained earnings for ABC, Inc. is: