Match the Weighted Average Cost of Capital to each of the scenarios given for AB

Question

Match the Weighted Average Cost of Capital to each of the scenarios given for ABC Corporation.

1.Target capital structure: 64% debt, 8% preferred stock and 28% common equity. Yield to maturity on bonds: 4.0%; Preferred stock dividend: $7.44 per year; current market price of preferred stock is $69.94. CAPM data for common equity: risk-free rate is 3.3%; market risk premium for the average stock is 5.6%; ABC has a beta of 1.88. ABC's marginal tax rate is 40%.

2.Target capital structure: 71% debt, 6% preferred stock and 23% common equity. Yield to maturity on bonds: 8.8%; Preferred stock dividend: $6.25 per year; current market price of preferred stock is $68.75. CAPM data for common equity: risk-free rate is 4.9%; market risk premium for the average stock is 7.5%; ABC has a beta of 0.92. ABC's marginal tax rate is 40%.

3.Target capital structure: 59% debt, 9% preferred stock and 32% common equity. Yield to maturity on bonds: 6.2%; Preferred stock dividend: $6.07 per year; current market price of preferred stock is $68.57. CAPM data for common equity: risk-free rate is 3.4%; market risk premium for the average stock is 9.9%; ABC has a beta of 0.82. ABC's marginal tax rate is 40%.

4.Target capital structure: 69% debt, 7% preferred stock and 24% common equity. Yield to maturity on bonds: 8.6%; Preferred stock dividend: $6.14 per year; current market price of preferred stock is $68.64. CAPM data for common equity: risk-free rate is 3.3%; market risk premium for the average stock is 10.5%; ABC has a beta of 0.79. ABC's marginal tax rate is 40%.

5.Target capital structure: 51% debt, 12% preferred stock and 37% common equity. Yield to maturity on bonds: 5.3%; Preferred stock dividend: $6.71 per year; current market price of preferred stock is $69.21. CAPM data for common equity: risk-free rate is 4.3%; market risk premium for the average stock is 4.5%; ABC has a beta of 1.84. ABC's marginal tax rate is 40%.

Explanation / Answer

1.
WACC=64%*4%*(1-40%)+8%*7.44/69.94+28%*(3.3%+1.88*5.6%)=6.2588552%
2.
WACC=71%*8.8%*(1-40%)+6%*6.25/68.75+23%*(4.9%+0.92*7.5%)=7.0082545%
3.
WACC=59%*6.2%*(1-40%)+9%*6.07/68.57+32%*(3.4%+0.82*9.9%)=6.6772641%
4.
WACC=69%*8.6%*(1-40%)+7%*6.14/68.64+24%*(3.3%+0.79*10.5%)=6.9693655%
5.
WACC=51%*5.3%*(1-40%)+12%*6.71/69.21+37%*(4.3%+1.84*4.5%)=7.4398157%

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