Question

The VWX Inc. has 100,000 bonds outstanding (1000$ each) that are selling at 100%. The bonds are yielding 7.5 percent. The company also has 1 million shares of preferred stock outstanding currently yielding 18.75 percent. It has also 5 million shares of common stock outstanding. The preferred stock sells for $56 per share and the common stock sells for $38 a share. The expected return on the common stock is 13.8%. The corporate tax rate is 34 percent. What is VWX Inc.’s weighted average cost of capital? (

Answer 1

Answer : WACC = 12.043755 or 12.04%

Calculation :-

WACC = (After tax cost of debt * Weight of debt) + ( Cost of preferred stock * Weight of Preferred stock) + (Cost of equity * Weight of equity)

where,

After tax cost of debt is 7.5% * ( 1- tax rate)

7.5 % * ( 1 - 0.34)

7.5 % * 0.66

4.95%

Cost of preferred stock is 18.75% (given)

Cost of equity is 13.80% (given)

Total Value = Debt value+ Preferred stock value + Equity value

= (100,000 * 1000) + (1,000,000 * 56 ) + ( 5,000,000 * 38)

= 100,000,000 + 56,000,000 + 190,000,000

= 346,000,000

Weight of debt = Debt value / Total value

= 100,000,000 / 346,000,000

= 0.2890

Weight of preferred stock = Preferred stock value / Total Value

= 56,000,000 / 346,000,000

= 0.1619

Weight of Equity = Equity Value / Total Value

= 190,000,000 / 346,000,000

= 0.5491

WACC = ( 4.95 * 0.2890 ) + ( 18.75 * 0.1619 ) + (13.80 * 0.5491 )

= 1.43055 + 3.035625 + 7.57758

= 12.043755 or 12.04 %