Preston Corp. is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent...

Preston Corp. is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sells for $1,100. The firm could sell, at par, $100 preferred stock which pays a 4.89 percent annual dividend, but flotation costs of 5 percent would be incurred. Preston's beta is 1.2, the risk-free rate is 3 percent, and the market risk premium is 5 percent. The firm's marginal tax rate is 40 percent. What is Preston's WACC?

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Expert Solution

Solution:

The cost of debt preferred capital and equity needs to be calculated for WACC.

The cost of debt is 5.386%

The cost of preferred stock = Dividend / ( price *(1-flotation cost)) = 4.89 / 100 *(1-0.05) = 4.89 /95 = 5.15%

The cost of equity = Risk-free rate + Beta * Risk premium = 3% + 1.2 *5% = 9%

The WACC is 7.08%

jeff jeffy answered 1 year ago

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