Your company has a target capital structure of 40% debt, 15% preferred, and 45% common equity....

Your company has a target capital structure of 40% debt, 15% preferred, and 45% common equity. Your bonds carry a 9% coupon, have a par value of $1,000, and 7 years remaining until maturity. They are currently selling for $950.51. The cost of preferred is 7.50%. The risk free rate is 4%, the market risk premium is 8%, and beta is 1.0. The firm will not be issuing any new stock, and the tax rate is 40%. What is its WACC?

a. 6.96% b. 8.93% c. 7.68% d. 7.59% e. 6.69%

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Expert Solution

Cost of debt is calculated using excel below

Therefore, cost of Debt = 10.0171%

According to CAPM, Required return on equity = Risk free rate+ Beta*(Risk premium)

= 4% + 1*(8%) = 12%

Therefore, cost of equity = 12%

WACC = Cost of equity*% of Equity+ Cost of Debt*% of Debt*(1-tax rate) +Cost of preferered stock*% of Preferred stock

= 12*0.45 + 10.0171*0.40*(1-0.40) +7.50*0.15

= 8.93%

jeff jeffy answered 1 year ago

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