Atlas Corporation has compiled the following data: The company\'s outstanding bo

Question

Atlas Corporation has compiled the following data: The company's outstanding bonds have a coupon rate of 10% and a yield to maturity of 11%. The marginal tax rate is 40%. Atlaspreferred stock has a price of $50 per share with an annual dividend of $6. The company just paid a dividend of $1.50, has a growth rate of 5%, and the common stock currently sells for $10. The firm's beta is 1.5, the risk free rate is 8%, and the expected return on the market is 12%. The firm's target capital structure is 30% debt, 10% preferred stock, and 60% common stock. Using the above information calculate: (a) after-tax cost of debt (b) cost of preferred stock (c) cost of common stock (d) Assuming the firm relies equally on the discounted cash flow and CAPM approaches to determine the cost of common equity, what is the WACC?

Explanation / Answer

After tax cost of debt = 11%*(1-.4) =6.66%

a)

Cost of Prefered stock = 6/50 =12%

b) Cost of Equity = 8% +1.5*(12% -8%)

= 14%

Cost of equity using dividend discount method = (1.5*1.05)/10 +5%

= 20.75%

d) COst of equity would be average of two methods =(20.75 +14)/2

= 17.375%

Hence wacc

= 30%*6.66% + 10%*12% + 60% * 17.38%

=13.62%

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