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Johnson Industries finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent...

Johnson Industries finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock.

·

The company can issue bonds at a yield to maturity of 7.4 percent.

·

The cost of preferred stock is 9 percent.

·

The company's common stock currently sells for $32 a share.

·

The company's dividend has just paid $2.00 a share (D0 = $2.00), and is expected to grow at a constant rate of 7 percent per year.

·

Assume that the flotation cost on debt and preferred stock is zero, and no new stock will be issued.

·

The company's tax rate is 30 percent.


What is the company's weighted average cost of capital (WACC)? Express your answer in percentage (without the % sign) and round it to two decimal places.

Solutions

Expert Solution

Information provided:

Yield to maturity= 7.4%

Cost of preferred stock= 9%

Current stock price= $32

Current stock dividend= $2

Dividend growth rate= 7%

Tax rate= 30%

The cost of common stock is calculated using the dividend discount model. It is calculated using the below formula:

Ke=D1/Po+g

where:

D1= Next year’s dividend

Po=Current stock price

g=Firm’s growth rate

Ke= $2*(1 + 0.07)/ $32 + 0.07

     = $2.14/ $32 + 0.07

     = 0.0669 + 0.07

     = 0.1369*100

     = 13.69%

The weighted average cost of capital is calculated using the below formula:

WACC=Wd*Kd(1-t)+Wps*Kps+We*Ke

where:

Wd= Percentage of debt in the capital structure.

Kd= The before tax cost of debt

Wps= Percentage of preferred stock in the capital structure

Kps=Cost of preferred stock

We=Percentage of equity in the capital structure

Ke= The cost of common equity.

T= Tax rate

WACC= 0.40*7.4%*(1 – 0.30) + 0.10*9% + 0.50*13.69%

            = 2.0720% + 0.9% + 6.8450%

            = 9.8170    9.82.

In case of any query, kindly comment on the solution.

jeff jeffy answered 9 months ago
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