CAPITAL STRUCTURE

Debt

55%

Pref. Stocks

5%

Common equity

40%

Additional information
Bond coupon rate

8.5%

Bond yield

7%

Bond flotation cost

2%

Dividends expected, common

1.50$

Price, common

30$

Dividends, preferred

5%

Flotation cost, preferred

3%

Flotation cost, common

4%

Corporation growth rate

6%

Corporation tax rate

35%

a) Calculate the cost of capital assuming use of internally generated

earnings.
b) Calculate the cost of capital assuming use of externally generated
earnings
c) Why is there a difference? Why does only common equity change?
Kd=

Y ( 1T )
8.5 (10.35)
=
=5.64%
1F
10.02

D0
1.50 $
Kp= P 0F = 30 $0.90 $ =5.15%
D0

Kp= P 0F = 100 3

D1

Ke= P 0

+g =

=5.15%

1.50 $
+6 =11%
30 $

D1
1.50 $
+g
+6
Kn= P 0
= 30 $
=11.46%
1F
10.04

a)
WACC (internally)
Kd
Ke
Kp
TOTAL

Cost
5.64%
11%
5.15%

Weight
55%
40%
5%

K*W
3.10%
4.40%
0.258%
7.76%

Cost
5.64%
11.46%
5.15%

Weight
55%
40%
5%

K*W
3.10%
4.58%
0.258%
7.94%

b)
WACC (externally)
Kd
Kn
Kp
TOTAL
c)
Because common equity can be achieved both through retaining dividends or
issuing shares, while the other cannot. The method to achieve internally
generated equity and externally generated equity differ in the method, the first
being done by the company itself while the second one involves asking both old
and potential shareholders for the required capital, which needs certain protocol
and legal conditions to be fulfilled.