Question

The Standard and Poor’s index retuned 8% in 1993 when treasury rates were

       2%. Hall Industries had a beta of 1.12. Hall Industries also has two bonds

       outstanding in equal amounts that yield 3% and 4% respectively. Hall

       Industries also has a preferred stock that yields 5%. The following weights

       are stocks 50%, bonds 20% and 20% and the preferred stock 10%. What is

       the Weighted Average Cost of Capital for Hall industries in1993 if taxes

       are .32%?

Answer 1

We have following information,

There are two types of debt

Before tax cost of debt 1 rd1 = 3%

Before tax cost of debt 2 rd2 = 4%

Tax rate = 32%

Yield of preferred stock Kps = 5%

Now we have to calculate the firms cost of common stock

Formula for the calculation of Firms cost of common stock = Risk-free rate + beta of stock * (market return – risk-free rate)

Where,

Risk-free rate (treasury rates) = 2%

Market return (The Standard and Poor’s index retuned) = 8%

Beta of stock = 1.12

Therefore, Firm’s cost of common stock kcs = 2% + 1.12 * (8% - 2%) = 8.72%

Now we can calculate WACC of firm with the help of following formula

WACC = wd1 *kd1 (1-t) + wd2 *kd2 * (1-t) + wps * kps+ wcs * kcs

Where wd1 is the weight of debt 1 = 20%

wd2 is the weight of debt 2 = 20%

wps is the weight of preferred stock = 10%

wcs is the weight of common stock = 50%

Therefore

WACC = 20% * 3% (1-32%) + 20% * 4% (1-32%) + 10% * 5% + 50% * 8.72% = 5.812%.

Therefore the weighted average cost of capital of the company is 5.812%