The Floyd Company has employed you to determine its weighted average cost of cap
ID: 2752322 • 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
Solution :
The weighted average cost of capital = We re + Wp rp + Wd rd (1-tc )
re = Rf + beta ( Rm - Rf )
re = 0.04 + 1.5 X ( 0.14 - 0.04)
re = 0.19 ( 19%)
Yield on preferred shares = dividend / current price of preferred share
Yield on preferred shares = $ 2.50 / $ 50
rp = 5%
Annual coupon rate = 7%
Semi annual coupon rate = 3.5 %
rd = 3.5%
Total value of current debt = 3000 X $ 105
Total value of current debt = $ 315,000
Total value of preferred stock = 20,000 X $ 50
Total value of preferred stock = $ 1,000,000
Total value of common stock = 50000 X $ 35
Total value of common stock = $ 1,750,000
Total value of debt + preference + common stock = $ 3,065,000
Proportion of debt = $ 315,000 / $ 3,065,000
Wd = 0.103
Proportion of preferred stock = $ 1,000,000 / $ 3,065,000
Wp = 0.33
Proportion of common stock =$ 1,750,000 / $ 3,065,000
We = 0.57
Weighted average cost of capital = 0.57 X 0.19 + 0.33 X 0.05 + 0.103X0.0305 (1-0.40)
WACC = 12.66 %
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