Brady Inc. has a targeted capital structure of 40% debt, 10% preferred stock, an

Question

Brady Inc. has a targeted capital structure of 40% debt, 10% preferred stock, and 50% common stock. The marginal tax rate is 35%. Use the data below to calculate the companys WACC. Ignore flotation costs.

The S&P 500 is expected to be up 12% over the next year.

Brady's preferred stock that is being traded in the marketplace pays an annual dividend of $8.00.

Brady's common stock sells for $25.00 per share. The expected dividend on the common stock next year is $2.00 per share.

Brady's bonds sell at a discount. The ten year bonds are priced at 97% of par ($1000 par value). They are annual bonds with a 7% coupon rate.

Brady's preferred stock sells for $75 per share. Treasury bonds are priced to yield 4%.

Management feels its investors expect a 6% growth rate for the stock. The beta of the stock is 1.2.

Explanation / Answer

WACC can be calculated as follows

WACC = Debt weight * After tax cost of debt + Equity weight * cost of equity + Preferred equity weight * cost of preferred equity

Debt weight =40%

Equity weight =50%

Preferred equity weight =10%

Cost of equity can be calculated using CAPM model as follows

Cost of equity = Risk free rate + Beta * (Market return - risk free rate)

Cost of equity = 4% + 1.2 * (12%-4%) = 13.6%

Cost of preferred equity = Annual dividend / Current price of preferred stock = 8 / 75 = 10.67%

Cost of debt = YTM of the bond, which can be calculated as follows

YTM =YIELD(A1,A2,7%,97,100,1) = 7.44%

WACC = 40% * 7.44% * (1-35%) + 10% * 10.67% + 50% * 13.6% = 9.80%

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