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

Equity:

Cost of equity = 108000*$18.48 =$1,995,840

As Risk Prem MRP = 3%

Ke = Krf + MRP = 3%+3% = 6%

US trasury Bond Krf = 3%

DEbt : Face value = FV=1000,

nper = 20-5=15, PMT = 11%*1000 =110

Kd =rate= 9%

SO Current price = PV(nper,rate,pmt,fv)

= PV(15,9%,110,1000) =$780.78

So Current cst of Debt = 1000*-$780.78 = $780780

Current price of Pref share = Dp/Kp = (7.50/2)/11% = $34.09

So Pref share capital = 2000*$34.09= $93,760

So Total Equity =$1,995,840 +780780 +$68,180 = $2,844,800

So Wd=780780 /$2,844,800 =27.45%

We= $1,995,840/$2,844,800=70.16%

Wp =$68,180 /$2,844,800 =2.40%

We have

WACC (Ka)= Wd*(Kd)*(1-t) + (We)*(Ke) + (Wp)*(Kp)

where Wd= The proportion of the financing taken on by debt

We= The proportion of the financing provided by equity

T=37%

And WACC (Ka) = Wd*(Kd)*(1-t)+ (We)*(Ke)+Wp*Kp

ie wacc = 27.45%*9%*(1-37%) + 70.16%*6% + 2.40%*11%

= 6.03%

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