Question

The Cullumber Products Co. currently has debt with a market value of $300 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,429.26 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $20 per share. The preferred shares pay an annual dividend of $1.20. Cullumber also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 6 percent per year forever. If Cullumber is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?

Excel Template
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Calculate the weights for debt, common equity, and preferred equity. (Round intermediate calculations and final answers to 4 decimal places, e.g. 1.2514.)

Debt
Preferred equity
Common equity

Calculate the cost of debt. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Cost of debt

%

Calculate the cost of preferred equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Cost of preferred equity

%

Calculate the cost of common equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 0 decimal places, e.g. 15%.)

Cost of common equity

%

What is the firm’s weighted average cost of capital? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

WACC

Answer 1

	Weight
Debt	0.4839
Preferred equity	0.0645
Common equity	0.4516

Cost of debt = YTM*(1-Tax)	2.95%
Cost of preferred equity=Dividend/Price	6.00%
Cost of equity=D1/P+g	17.00%
WACC	9.49%

Workings

	Market value in millions	Weight
Debt	300000000	0.4839
Preferred equity	40000000	0.0645
Common equity	280000000	0.4516
Total value	620000000
YTM of debt	4.92%