Based on the information below, calculate the weighted average cost of capital.

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%. Please show formula/calculations..

Explanation / Answer

Hi,

Please find the answer as follows:

Debt:

Cost of Debt = 8*(1-.36) = 5.12%

Selling Price of each Bond = Pb = PMT[PVFAk,n] + FV[PVFk,n]

= 51.2*(PVFA 4.5, 50) + 1000*(PVF 4.5, 50)

= 51.2*19.726 + 1000*.1107 = 1120.67

Market Value of Bond = 1120.67*1000 = 1120670

Preferred Stock

Value of each share of preferred stock is = 7.5/.08 = 93.75

Market Value of Preferred Stock = 2000*93.75 = 187500

Equity

Cost of Equity = 1/14.48 + .05 = 11.91%

Market Value of Equity = 125000*14.48 = 1810000

Calculation of WACC

WACC = 9.66%

Thanks.

Instrument Market Value Weight (A) Cost (B) WACC (A*B) Debt 1120670 35.94% 5.12 1.84 Preferred Stock 187500 6.01% 15 0.90 Equity 1810000 58.05% 11.91 6.91 Total 3118170

9.66

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