HFT – 4464
Hospitality Industry Finance
Chapter 8 Worksheet
Highway Inn has determined that their current capital structure is optimal consisting of 60% common equity, 10% preferred stock
and 30% debt. They need $100,000,000 to add a new wing. Highway Inn has $20,000,000 in retained earnings to help finance
this project. Given the following data, what is the weighted average cost of capital for this project?
a) Highway Inn’s Bonds have a face value of $1,000 and offers a 8% coupon rate and matures in 15 years. The issuance cost per
bond is $80.64 each
b) Preferred stock is selling at $50 per share with a $3 per share issuance cost. The preferred stock offers $5 per share annual
dividend.
c) Common stock is selling at $25 per share and has a issuance cost of $4 per share. The dividend for NEXT YEAR will be
$3.00 and will grow at 4% annually thereafter.
d) Highway Inn’s Marginal Tax Rate is 40%
Step 1) Determine the Before Tax Cost of Capital for Debt
Step 2) Determine the After Tax Cost of Capital for Debt
Step 3) Determine the Cost of Capital for Preferred Stock
Step 4) Determine the Cost of Internal Equity for Common Stock
Step 5) Determine the Cost of External Equity for Common Stock
Step 6) Determine the % financed by each component
Step 7) Determine the Weighted Average Cost of Capital for the Project
Step 1) Determine the Before Tax Cost of Capital for Debt
Before Tax Cost of Capital for Debt is the interest rate that makes the coupon payments and the face value equal the net proceeds
received when the bond was sold
Net Proceeds = ( Coupon payment * PVA ) + ( Face Value * PVLS )
( Face Value – Issue Cost ) = ( Coupon payment * PVA ) + ( Face Value * PVLS )
Step 2) Determine the After Tax Cost of Capital for Debt
After Tax Cost Of Capital = Before Tax Cost of Capital * ( 1 – marginal tax rate )
Step 3) Determine the Cost of Capital for Preferred Stock
Cost of Capital Preferred Stock = Preferred Stock Dividend / Net Proceeds Preferred Stock
Step 4) Determine the Cost of Internal Equity for Common Stock
Cost of Internal Equity for Common Stock = ( C.S. Dividend / Net Proceeds C.S. ) + Growth
Step 5) Determine the Cost of External Equity for Common Stock
Cost of External Equity for Common Stock = ( C.S. Dividend / Net Proceeds C.S. ) + Growth
Step 6) Determine the % financed by each component
Optimal Structure is 60% common equity, 10% preferred stock and 30% debt.
Step 7) Determine the Weighted Average Cost of Capital for the Project
Weighted Average Cost of Capital (W.A.C.C.) =
Percent Financed by Debt * After Tax Cost of Debt
+ Percent Financed by Preferred Stock * Cost of Preferred Stock
+ Percent Financed by Common Stock Internal * Cost of Common Stock Internal
+ Percent Financed by Common Stock External * Cost of Common Stock External