The Floyd Company has employed you to determine its weighted average cost of cap
ID: 2752320 • Letter: T
Question
The Floyd Company has employed you to determine its weighted average cost of capital. The net income is projected to be $504,545 during the coming year. The marginal tax rate is 40%. Debt: Floyd has 3,000 7 percent coupon bonds outstanding, with 20 years to maturity, and a quoted price of 105. The bonds pay the coupons on a semi-annual basis. Preferred: Floyd has 20,000 shares of preferred stock. The preferred dividend is 2.50 and the current price is $50 per share. Common Equity: Floyd has 50,000 shares of common stock selling for $35 per share. The firm’s beta is 1.5 Market: The expected return on the market is 14% and the risk free rate is 4 percent. Determine the cost of capital.
Explanation / Answer
Cost of Equity = Risk free rate + Beta ( Return on market - Risk free rate)
= 4 + 1.5 ( 14 - 4)
= 19%
Cost of Preference shares = Preference dividend / Net Proceeds per share * 100
= 2.50 / 50 * 100
= 5%
Cost of debt = Interest ( 1 - t) + (Redemption value - Net proceeds) / Life of debenture * 100
( Redemption value + Net proceeds) / 2
Assuming Debt redeemed at Par. ( Say $ 100)
Interest = 3000 * 100 * 7% * 6 /12 = 10500 ( Semi-anually at Face value)
Redemption value = 3000 * 100 = 300000
Net proceeds = 3000 * 105 = 315000 (Quoted price)
Cost of debt = 10500 ( 1 - 0.40) + (300000 - 315000) / 40(NOTE 1) * 100
( 300000 + 315000) / 2
= 6300 - 375 / 307500 * 100
= 1.93 % (approx)
(NOTE 1) = 20 * 2 = 40 Semi-annual periods.
Calculation of weighted average cost of capital:- (At Market value weights)
Conclusion:- Weighted average cost of capital ( At market value) = 12.673%
Amount Weight Cost Weight * Cost Debt = 3000 * 105 315000 0.10 1.93 0.193 Equity = 50000 * 35 1750000 0.57 19 10.83 Preference shares = 20000 * 50 1000000 0.33 5 1.65 Total 3065000 1 12.673 %Related Questions
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