MNO\'s capital structure includes bonds, preferred stock, and common stock. The
ID: 2785355 • Letter: M
Question
MNO's capital structure includes bonds, preferred stock, and common stock. The target capital structure calls for 43 percent common stock, 18 percent preferred stock, and the remainder as bonds. The company's bonds have a yield to maturity of 6.8 percent. The company's preferred stock, which sells for $67.58 per share, pays an annual dividend of $5.8. The market risk premium for the average common stock is 13 percent and the risk-free rate is 3.8 percent. MNO stock has a beta of 1.6. If MNO's marginal tax rate is 40 percent, then what is MNO's weighted average cost of capital? (Show your answer in decimal for to three places, e.g., 12.3% would be entered as 0.123)
Explanation / Answer
Cost of debt after tax=6.8(1-0.4)=0.0408
Cost of preferred stcok=Annual dividend/Current price
=(5.8/67.58)=0.085824208
Cost of equity=Risk free rate+Beta*Market risk premium
=3.8+1.6*13=0.246
Hence WACC=Respective costs*Respective weights
=(0.43*0.246)+(0.18*0.085824208)+(0.39*0.0408)(Weight of bonds=(100-43-18)=39%)
=0.137(Approx).
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