Question

1) A compant has 50,000 shares of common stock outstanding at a market price of $20 a share. The common stock just paid a $1 annual dividend and has a divided growth rate of 5 percent. What is the total market value of common stock? What is the cost of equity (common stock)?

2) There are 12,000 shares of 6 percent preferred stock outstanding at a market price of $51 a share. What is the total market value of preferred stock? What is the cost of preffered stock?

3) The outstanding bonds mature in 15 years, have a total face value of $750,000, a face value per bond of $1,000, and a market price of $1,050 each. The bonds pay 8 percent interest, semiannually. What is the total bond market value? What is the cost of debt?

4) Use the results from questions 1-3 to compute the weight of equity (common stock), the weight of preferred stock, and the weight of debt.

5) The tax rate is 15 percent. Computer WACC?

Answer 1

1. Total market value of common stock = No. of outstanding shares * Market value per share = 50,000 * $20

= $1,000,000

Cost of equity (common stock) = (Expected dividend next year / Current market value of common stock) + Expected growth rate of dividends

= (1.05 / 20) + 5%

=10.25%

2. Total market value of preferred stock = No. of outstanding shares * Market value per share = 12,000 * $51

= $612,000

Cost of preferred stock (assuming face value of preferred stock as $100)

= (Annual dividends / Current market value of preferred stock) = 6 / 51

=11.77%

3. Total bond market value = No. of outstanding bonds * Market value per bond = 750 * $1,050

= $787,500

Cost of debt (using current yeild method) = (Coupon rate * Face value) / Current market price

= (8% * 1000) / 1050

= 7.6%

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

= 7.6% * 0.85 = 6.46%

4. Calculating the weight of common stock(Wcs), preferred stock (Wps) and bonds (Wb) based on the current market values of each.

Total capital = current market value of common stock + current market value preferred stock + current market value of bonds

= $1,000,000 + $612,000 + $787,500

=$2,399,500

Therefore, Wcs = total market value of common stock / total market value of all the capital

= 1,000,000 / 2,399,500 = 0.417

Wps = total market value of preferred stock / total market value of all the capital

= 612,000 / 2,399,500 = 0.255

Wb = total market value of bond / total market value of all the capital

= 787,500 / 2,399,500 = 0.328

5. Calculating WACC

WACC = (Weight of common stock)(cost of common stock) + (Weight of preferred stock)(cost of preferred stock) + (Weight of bond)(cost of bond)

=(0.417)(10.25) + (0.255)(11.77) + (0.328)(6.46)

=4.27 + 3.00 + 2.12

= 9.39%