Assume the following capital structure: Debt 30% Preferred stock 20% Common equity 50 % The...

Question:

Assume the following capital structure:

Debt 30%

Preferred stock 20%

Common equity 50 %

The following facts are provided:

Bond yield to maturity 6%

Corporate tax rate 35%

Dividend, Pre. Stock $2.00

Price, Pre. Stock $35.00

Floatation, Pre. stock $1.00

Dividend (Do), Com. Stock $2.00

Price, Com. Stock $25.00

Growth rate, Com. Stock 4%

Compute the weighted average cost of capital.

The weighted average cost of capital:

Three steps to calculate WACC

1. Determine the cost of various sources of finance.

2. Determine the weight associated with the various source of finance.

3.Multiply the costs of various sources of finance with the corresponding weights and add these weighted costs to determine the WACC.

Answer and Explanation:

  • Cost of Debt: cost of debt - Cost of debt *Tax rate

= 6 - 6* 0.35 = 3.9%

  • Cost of preference stock = Dividend/cost of preference share

= 2/34 = 5.88 %

Note: floating cost reduce from stock price

  • cost of equity stock=

G= 4 %

D0= $2

p= $25

K e ={eq}\frac{D1}{p} + g {/eq}

= 2.08/25 +.04

= 12.32%

Cost of capital Weightage WACC
3.9 0.3 1.17%
5.88 0.2 1.17%
12.32 0.5 6.16%
Total WACC 8.50%

Learn more about this topic:

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Capital Structure & the Cost of Capital

from Finance 101: Principles of Finance

Chapter 15 / Lesson 1
10K

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