Question

a XXX123 has 66,000 bonds outstanding that are selling at par. The face value of each bond is $1,000. Bonds with similar characteristics have yield to maturity of 7.5 percent. The company also has 600,000 shares of preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $40 a share and pays annual dividends of $4 per share. The common stock has beta of 1.25 and sells for $44 a share. The risk free rate is 3.0 percent and the return on the market is 12 percent. The corporate tax rate is 21 percent. What is the firm's weighted average cost of capital?

Group of answer choices

10.30%

9.96%

13.44%

11.51%

12.36%

Answer 1

- No of Bonds outstanding = 66,000

Selling at par =$1,000

Total Value of Bond = 66,000*$1,000

=$66,000,000

YTM = 7.5%

- No of shares of Preferred Stock = 600,000

Selling price of Preferred Stock =$40

Total value of Preferred Stock = 600,000*$40

=$24,000,000

Cost of Preferred Stock = Annual Dividend/Share Price

=$4/$40

=10%

- No of Shares outstanding of Common Stock = 2,500,000

Share Price = $44

Total value of Common Stock = 2,500,000*$44

=$110,000,000

As per CAPM,

R_f = Risk free Return = 3%                                                    

R_m = Market return = 12%

Beta = 1.25

Required return = 3% + 1.25(12% - 3%)

= 14.25%

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

=$66,000,000 + $24,000,000 + $110,000,000

= $200,000,000

Calculating WACC:-

WACC= (Weight of Debt)(Cost of Debt) + (Weight of Common stock)(Cost of Common Stock) +(Weight of Preferred Stock)(Cost of Preferred Stock)

WACC = (66M/200M)*(7.5%) + (110M/200M)(14.25%) + (24M/200M)(10%)

WACC = 2.475% + 7.83915% + 1.2%

WACC = 11.51%