MNO\'s capital structure includes bonds, preferred stock, and common stock. The
ID: 2787860 • Letter: M
Question
MNO's capital structure includes bonds, preferred stock, and common stock. The target capital structure calls for 46 percent common stock, 14 percent preferred stock, and the remainder as bonds. The company's bonds have a yield to maturity of 7.1 percent. The company's preferred stock, which sells for $63.94 per share, pays an annual dividend of $6.77. The market risk premium for the average common stock is 12 percent and the risk-free rate is 3.4 percent. MNO stock has a beta of 2. 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=7.1(1-0.4)=4.26%
Cost of preferred stock=annual dividend/Current price
=(6.77/63.94)=10.5880513%
Cost of equity=Risk free rate+Beta*MArket risk premium
=3.4+12*2=27.4%
Weight of bonds=(100-46-14)=40%
WACC=Respective costs*Respective weights
=(4.26*0.4)+(10.5880513*0.14)+(27.4*0.46)
=0.158(Approx)
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