Question

21-A companyhas a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. Theyield to maturity on its bonds is 7.4%, and investors require 8% return on the company’spreferred and 14% return on thecommon stock. If the tax rate is 35%, what is thecurrent WACCof this company?

Answer 1

Total Value = Debt + Preferred stock + Common equity = $7 million + $2 million + $11 million = $20 million

Weight of Debt = Debt / Total Value = $7 million / $20 million = 0.35

Weight of Preferred stock = Preferred stock / Total Value = $2 million / $20 million = 0.10

Weight of Common equity = Common equity / Total Value = $11 million / $20 million = 0.55

rd = Yeild to maturity on bonds = 7.4%

rp = Return on preferred stock = 8%

re = Return on Common equity = 14%

t = tax rate = 35%

WACC = [Wd * rd * (1-t)] + [Wp * rp] + [We * re]

= [0.35 * 7.4% * (1-35%)] + [0.10 * 8%] + [0.55 * 14%]

= 1.6835% + 0.8% + 7.7%

= 10.1835%

Therefore, Current WACC of the company is 10.18%