Question

Wildhorse Corporation is financed with debt, preferred equity, and common equity with market values of $25 million, $13 million, and $32 million, respectively. The betas for the debt, preferred stock, and common stock are 0.3, 0.5, and 1.2, respectively. The risk-free rate is 4.00 percent, the market risk premium is 6.01 percent, and Wildhorse’s average and marginal tax rates are both 30 percent.

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(a1)

What is the company’s cost of capital? (Round intermediate calculation to 4 decimal places, e.g. 1.2512 and final answers to 3 decimal places e.g. 5.215%.)

Costs of debt			%
Costs of common equity			%
Costs of preferred equity

Costs of debt ? Costs of common Equity? Costs of preferred equity ?

Answer 1

Costs of debt

As per CAPM

expected return = risk-free rate + beta * (Market risk premium)

Expected return% = 4 + 0.3 * (6.01)

Expected return% = 5.8

Costs of common equity

As per CAPM

expected return = risk-free rate + beta * (Market risk premium)

Expected return% = 4 + 1.2 * (6.01)

Expected return% = 11.21

Costs of preferred equity

As per CAPM

expected return = risk-free rate + beta * (Market risk premium)

Expected return% = 4 + 0.5 * (6.01)

Expected return% = 7.01

Total capital value = Value of debt + Value of preferred equity + Value of common equity

=25+13+32

=70

Weight of debt = Value of debt/Total capital Value

= 25/70

=0.3571

Weight of preferred equity = Value of preferred equity/Total capital Value

= 13/70

=0.1857

Weight of common equity = Value of common equity/Total capital Value

= 32/70

=0.4571

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

After tax cost of debt = 5.8*(1-0.3)

= 4.06

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

WACC=4.06*0.3571+11.21*0.4571

WACC =6.57%