The management of Company GV believes that the firm’s current capital structure
ID: 2789539 • Letter: T
Question
The management of Company GV believes that the firm’s current capital structure is optimal and plans to maintain it. This company has 50,000 bonds outstanding and the face value of each of these bonds is $1,000. The company has 10,000,000 shares of common stocks outstanding. The stock was issued at $40 each. The preferred stocks issued by this company were 2,500,000 shares and the issuing price was $20 per share.
Company GV has a beta of 1.2. The Treasury Bond yields 5.5 percent and return of the market portfolio is 11.5 percent. The company pays a dividend of $2 to its preferred stockholders. The coupon interest rate of the company bond is 9.5 percent. If the company is in the 30 percent tax bracket, what is the WACC of this company?
Explanation / Answer
Cost of equity = Rf + Beta x (Rm - Rf) Cost of equity = 5.5% + 1.2 x (11.5% - 5.5%) 12.70% Market Capitalisation = $10,000,000 shares x $40 $400,000,000 Cost of Preferred capital = Dividend/ Price $2/$20 10.00% Market cap. preferred = 2,500,000 x $20 $50,000,000 Cost of debt after tax = 9.50% x(1-30%) 6.65% Market cap. debt = 50,000 x $1000 $50,000,000 Market Cap. Weights Cost WACC = weight x cost Equity $400,000,000 80.00% 12.70% 10.16% Preferred $50,000,000 10.00% 10.00% 1.00% Debt $50,000,000 10.00% 6.65% 0.66% Total $500,000,000 100.00% 11.82%
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