Bubba Equipment has the following financial information: 1) 50,000 bonds outstan

Question

Bubba Equipment has the following financial information:

1) 50,000 bonds outstanding with a 20 year maturity and 4 % annual coupon, selling for $950

2) 500,000 shares of 5 percent preferred stock. $100 par value per share, selling for $80 per share

3) 2.0 million shares of common stock outstanding. beta of 1.20. sells for $50 a share. recen annual dividend was $3 and projected growh rate is 6%

(the us treasury bill is yielding 3 percent)
(return on the market is 10 percent)

(corporate tax rate is 30 percent)

take everything to 4 decimal places

Q: What is the firm's weighted average cost of capital?(Use CAPM version for equity)

Explanation / Answer

market value of bonds=50000*950=47500000
market value of preferred stock=500000*80=40000000
market value of equity=2000000*50=100000000

Weight of bonds=47500000/(47500000+40000000+100000000)=0.2533
Weight of prferred stock=400000/(47500000+40000000+100000000)=0.002133
Weight of equity=100000000/(47500000+40000000+100000000)=0.5333

Preferred DIvidend=100*5%=5

Cost of preferred stock=Preferred Dividend/Preferred stock price=5/80=6.25%

YTM of bonds=4.3804%

after tax cost of debt=4.3804*(1-30%)=3.06628%

cost of equity accoridng to CAPM=risk free rate+beta*market risk premium=3%+1.2*(10%-3%)=11.4%

WACC=11.4%*0.5333+3.06628%*0.2533+6.25%*0.002133=6.8696%

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