Based on the information below, calculate the weighted average cost of capital.
ID: 2629638 • Letter: B
Question
Based on the information below, calculate the weighted average cost of capital. Great Corporation has the following capital situation. Debt: One thousand bonds were issued five years ago at a coupon rate of 8%. They had 25-year terms and $1,000 face values. They are now selling to yield 9%. The tax rate is 36% Preferred stock: Two thousand shares of preferred are outstanding, each of which pays an annual dividend of $7.50. They originally sold to yield 15% of their $50 face value. They're now selling to yield 8%. Equity: Great Corp has 125,000 shares of common stock outstanding, currently selling at $14.48 per share. Dividend expected for next year is $1.00 and the growth rate is 5%.
Explanation / Answer
Cost of Common Stock
Cost of Equity as per dividend growth model
P= D1/ (k-g)
Where P= Current Market price of common stock
D1= Next year expected dividend
K= Cost of equity
G= Expected growth rate
By above formula we get
k = (D1/P) +g
In the given problem D1=$1, g= 5%, P= $14.48
By putting value we get cost of common stock
K= rE= 11.91%
Cost of Preferred Stock
As we know that currently preferred stock are selling at 8% yield
Hence current market price of preferred stock will be derived as follows.
Current Market Price= Dividend/ Yield %
= 7.5/ .08
Current market price= $ 93.75
Cost of Preferred stock= Dividend / Current Market Price
= $7.5/ 93.75
Therefore cost of preferred stock
rP= 8%
Cost of Debt
Currently bond are selling to yield 9% yield
Hence cost of debt, rD= 9%
Post Tax Cost of debt= 9(1-0.36)= 5.76%
Weighted Average Cost of Capital
WACC= (weight of equity x cost of equity) +( weight of debt x cost of debt)+ ( weight of preferred stock x cost of preferred stock)
Market Price of Debt (bond)= Coupon Payment/Current yield
= 80/.09
= $888.89
Market Value of Debt= 1000 x $888.89= $888890
Market Value of Preferred stock= No of Stock x Current Market Price
= 2000 x 93.75
Market Value of Preferred stock= $ 187500
Market Value of Common Stock= 125000 x $ 14.48
Market Value of Common Stock = $1810000
Particular
Common Stock
Preferred Stock
Debt
Total
Market Value
1810000
187500
888890
2886390
Weight to Total Market Value
0.627081
0.06496
0.307959
1.00
Cost
11.91
8
5.76
Weighted Cost
7.468533
0.51968
1.77384
9.762058
Hence WACC= 9.76%
K= rE= 11.91%
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