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 11%. They had 20-year terms and $1,000 face values. They are now selling to yield 9%. The tax rate is 37%
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 11%.
Equity: Great Corp has 108,000 shares of common stock outstanding, currently selling at $18.48 per share. Use the risk premium approach and assume a 3% risk premium

Explanation / Answer

price of bond = 110 * PVIFA(9%,15) + 1000 * PVIF(9%,15)

=110 * 8.0607 + 1000 * 0.2745

= 1221.27

value of debt = 1000 * 1221.27 = 1221270

value of each share of preferred stock = 7.50/0.11 = 68.18

value of preferrd stock = 68.18 * 2000 =136360

value of common stock = 108000 * 18.48 = 1995840

value of firm = 1221270 + 136360 + 1995840 = 3353470

cost of debt = 9% * (1-0.37) = 5.67%

cost of preferred stock = 11%/(1-0.15) = 12.94%

cost of equity = 9% + 3% = 12%

WACC = (1221270/3353470) * 5.67% + (136360/3353470) * 12.94% + (1995840/3353470) * 12%

= 9.73%

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