Falcon Ridge Developers wants to compute the firm’s WACC for capital budgeting p
ID: 2713830 • Letter: F
Question
Falcon Ridge Developers wants to compute the firm’s WACC for capital budgeting purposes. The firm uses 30% debt, 20% preferred stock and the remainder is in equity. The YTM on the firm’s debt is currently 4.5% and the firm’s marginal tax rate is 40%. They pay a dividend of $3 on their preferred stock and the current price of the preferred stock is $75. Falcon’s most recent common dividend was also $3, but has been growing at a rate of 8% per year and is expected to continue that trend. The common stock is currently selling for $50. Calculate the firm’s WACC.
Explanation / Answer
Calculation of Weighted Average Cost of Capital (WACC):
Formula :
WACC = (Cost of Equity * Weight of Equity ) + (Cost of Pref. Stock * Weight of Pref. Stock )+ (Cost of Debt * Weight of Debt )
Cost of Equity =( Current Dividend * (1+ growth rate) / Current Price ) + Growth rate
= (3 * (1+8%) / 50 ) + 8%
= (3.24 /50) + 0.08
= 0.0648+ 0.08
= 0.1448
= 14.48%
Cost of Pref. Stock = Dividend / Price =3 / 75 = 0.04 = 4%
Cost of Debt = YTM * (1- tax rate ) = 4.5% * (1-40%) = 2.7%
Weight of Equity = 100%-30%-20% = 50%
Weight of Pref. Stock = 20%
Weight of Debt = 30%
Hence WACC = (14.48% *50%) + (4%*20%) + (2.7% *30%)
= 8.85%
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