Question

Q1: Calculate the standard deviation of returns on a stock that had the following

returns in the past three years:

Year Return

   1 9%

                                                        2 -12%

                                                        3 18%

Q:

A company has a target capital structure of 55% common stock, 10% preferred

      stock, and 35% debt. Its cost of equity is 13%, the cost of preferred stock is 7%,  

      and the cost of debt is 8%. The relevant tax rate is 30%. What is the company’s

      Weighted Average Cost of Capital?

Answer 1

QUESTION-1

Average Return

Average Return = Total Returns / Number of years

= [9.00% - 12.00% + 18.00%] / 3 Years

= 15.00% / 3 Years

= 5.00%

Variance of the returns

Variance of the returns = [(9.00 – 5.00)² + (-12.00 – 5.00)² + (18.00 – 5.00)²] x 1/3

= [16.00 + 289.00 + 169.00] x 1/3

= 474.00 x 1/3

= 158.00

Standard Deviation of the return

Standard Deviation of the return = Square Root of 158.00 or [158.00]^1/2

= 12.57%

QUESTION-2

Company’s Weighted Average Cost of Capital (WACC)

The Weighted Average Cost of Capital (WACC) is calculated by using the flowing formula

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

Here, we’ve After Tax Cost of Debt = 5.60% [8.00% x (1 – 0.30)]

Cost of Preferred stock = 7.00%

Cost of equity = 13.00%

Weight of Debt = 0.35

Weight of Preferred Stock = 0.10

Weight of Equity = 0.55

Therefore, the Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

= [5.60% x 0.35] + [7.00% x 0.10] + [13.00% x 0.55]

= 1.96% + 0.70% + 7.15%

= 9.81%