Rotvec Manufacturing Company (RMC) is a publicly held company with common stock listed on the Zurich Stock Exchange (ZSE) and bonds traded over the counter. As of the current balance sheet, it has three bond issues outstanding:
$150 million of 10 percent series 2021
$50 million of 7 percent series 2019
$60 million of 6 percent series 2017
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The finance manager of the company, Mr. Briman,is planning to sell $60 million of bonds next year to replace the debt due to expire in late 2017. Present market yields on similar Baa-rated bonds are 12.80 percent. RMC also has $90 million of 7.5 percent non-callable preferred stock outstanding, and it has no intentions of selling any preferred stock at any time in the future. The preferred stock is currently priced at $80 per share at ZSE, and its dividend per share is $7.80.
The company has had very volatile earnings, but its dividends per share have had a very stable growth rate of 6 percent and this will continue. Last dividend paid by RMC was$1.76 per share, and the common stock is selling for $40 per share. The company’s investment banker has quoted the following flotation costs to RMC: $2.30 per share for preferred stock and $2.10 per share for common stock.
RMC has kept its debt at 50 percent of assets and its equity at 50 percent. RMC sees no need to sell either common or preferred stock in the foreseeable future as it has generated enough internal funds for its investment needs when these funds are combined with debt financing. RMC’s corporate tax rate is 35 percent.
Please compute:
1. Cost of Bond (debt).
2. Cost of Preferred stock.
3. Cost of Common equity in the form of retained earnings.
4. Cost of New common stock.
5. WACC.
In 5 lines, please explain how you calculate WACC for RMC.
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