Question

You have been provided the following information inc.

debt: the market value is 50000 the bonds are currently yielding 9% and have a coupon rate of 8%.

common: 2000 shares outstanding, selling for $60 per share; the beta is 1.2

stock: preferred 500 shares of preferred stock outstanding, currently selling for $75 per share

Stock: that pays 7.5 in dividends per year per share

market: 8 percent market risk premium and 3.4 percent risk-free rate.

1. compute the capital structure weights of each component of the capital.

2. if the company's tax rate is 25%, what is its WACC?

Answer 1

- Market value of Bond = $50,000

- Market Value of Common Stock = No of shares outstanding*Price per share

= 2000 shares*$60 per share = $120,000

- Market value of Preferred stock = No of Preferred shares outstanding*Price per share

=500 shares*$75 per share

= $ 37,500

Total Capital Structure = Market value of Bond + Market Value of Common Stock + Market value of Preferred stock

= $ 50,000 + $120,000 + $37,500

= $207,500

a). Now, Calculating the Capital structure weight structure of each component :-

Bond Weight= $50,000/$207,500

= 24.10%

Common Stock Weight = $120,000/$207,500

= 57.83%

Preferred Stock Weight = 37,500/207500

= 18.07%

b). Before-tax cost of Debt = 9% (we always Yield to comoute WACC)

Cost of Preferred Stock = Annual Dividend/Share Price

=$7.5/$75

= 10%

As per CAPM, Cost of Equity = Risk-free rate + Beta(Market Risk premim)

= 3.4% + 1.2(8%)

= 13%

Now, Computing WACC:-

WACC= (Weight of Debt)(Before-tax Cost of Debt)(1-Tax Rate) + (Weight of Equity)(Cost of Equity)+(Weight of Preferred Stock)(Cost of Preferred Stock)

WACC = (0.2410)(9%)(1-0.25) + (0.5783)(13%)+ (0.1807)(10%)

WACC = 1.62675% + 7.5179% + 1.807%

WACC = 10.95%

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