Question

G Corporation is estimating its WACC. Its target capital structure is 20% debt, 20% preferred stock, and 60% common equity. Its bonds have a 10% coupon, paid semiannually, a current maturity of 20 years, and sell for $850. The firm could sell, at par, $100 preferred stock which pays a 12% annual dividend. Greshak's beta is 1.2, the risk-free rate is 10%, and the market risk premium is 5%. The firm's marginal tax rate is 40%. What is the company’s WACC component cost of equity (r_s)?

Please show all work

Answer 1

Weight of equity = E/A

Weight of equity =

W(E)=0.6

Weight of debt = D/A

Weight of debt = 0.2

W(D)=0.2

Weight of preferred equity =1-D/A-E/A

Weight of preferred equity = =1-0.2 - 0.6

W(PE)=0.2

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 10 + 1.2 * (5)

Cost of equity% = 16

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =20x2

850 =∑ [(10*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^20x2

k=1

YTM = 11.9929618729

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 11.9929618729*(1-0.4)

= 7.19577712374

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 12/(100)*100

=12

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=7.2*0.2+16*0.6+12*0.2

WACC =13.44%