SCENARIO 10-6Viduka Construction\'s CFO has collected the following information

ID: 2756373 • Letter: S

Question

SCENARIO 10-6Viduka Construction's CFO has collected the following information to estimate the company's WACC:

· The company currently has 20-year, 8.5% annual coupon bonds that have a face value of $1,000 and sell for $945.

· The company's stock has a beta nar018-1.jpg 1.20.

· The market risk premium, RPm , equals 5%. · The risk-free rate is 6%.

· The company has outstanding preferred stock that pays a $2.00 annual dividend. The preferred stock sells for $25 a share. ·

The company's tax rate is 40%.

· The company's capital structure consists of 40% long-term debt, 40% common stock, and 20% preferred stock.

What is the company's WACC?

7.95%

8.12%

8.59%

8.67%

10.04%

Yield on bond = [Interest + (face value -price)/years ] /[(face value +price)/ 2]

= [85 + (1000 - 945 )/ 20 ]/[(1000+945 )/2]

= [85 + (55/20 ) ] /[1945 /2]

= [85 + 2.75] / 972.5

= 87.75 / 972.5

= .0902 or 9.02%

After tax yield = 9.02 (1 - .40 ) = 9.02 *.6 = 5.412%

cost of preferred stock =dividend /current price

= 2 / 25

= .08 or 8%

cost of common stock = Rf + [Beta *market premium]

= 6 + [1.2 * 5 ]

= 6 + 6

= 12%..

WACC = (5.412 * .40 )+( 8 * .20 )+(12 *.40 )

= 2.1648 + 1.6+ 4.8

= 8.56 %

Correct option is "C" - 8.59% (most approx to 8.59 % )

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