Need to understand step by step on how to do the below: (Non Excel) Phillips Equ

Question

Need to understand step by step on how to do the below: (Non Excel)

Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for$53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital?

Explanation / Answer

Weighted average cost of capital =

Cost of Bond + cost of preference shares + cost of common shares

Cost of equity = Rf + Beta (RM - RF)

                             2.8 + 1.34 (11.2 – 2.8)

                             2.8 + 11.26

                             14.056%

Cost of preference shares =

Let us take par value is Rs 100

7% is preference dividend

= 100 *0.07

= 7

Therefore cost of preference share is = 7/53 = 13.208

Cost of bonds = 6.75%

As of now we know about the cost of all the three ways of funds, Let us calculate total funds:

Bonds = 80,000 * 1000 ( par value is 1000)= 80 million

Preferred stock = 750,000 * 53

                             39,750,000= 39.75 million

Common stock = 2,500,000 * 42

                             105,000,000= 105 million

Therefore total capital= 224.75

Cost of capital = WACC= (105m/224.75m)(0.14056) = (39.75m/224.75m)(0.13208) + (80m/224.75m)(0.0675)(1-0.38)= 10.39%

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