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(WACC) A company has common stock, preferred shares, and debt outstanding. As of today, the common...

  1. (WACC) A company has common stock, preferred shares, and debt outstanding. As of today, the common stock is valued at $10 per share, with 2 million shares outstanding. It has a beta of 5, and market return is estimated to be 4% while treasury bills offer 1.5% risk-free rate. The preferred stock is valued at $15 per share, which pays dividend of $2 each year at a constant growth rate of 3%. Preferred stocks have 5 million shares outstanding. Finally, debt has a market value of $4 million dollars and pays an interest rate of 5%. Tax rate is 40%. Calculate WACC.

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Expert Solution

Weight of Capital Components

Market Value of Debt = $40,00,000

Market Value of Preferred Stock = $7,50,00,000 [50,00,000 Shares x $15 per share]

Market Value of Common Stock = $2,00,00,000 [20,00,000 Shares x $10 per share]

Total Market Value =$9,90,00,000 [$40,00,000 + $7,50,00,000 + $2,00,00,000]

Weight of Debt = 0.0404 [$40,00,000 / $9,90,00,000]

Weight of Preferred Stock = 0.7576 [$750,00,000 / $990,00,000]

Weight of Common Stock = 0.2020 [$200,00,000 / $990,00,000]

Cost of Capital

After- Tax Cost of Debt

After- Tax Cost of Debt = Interest Rate x (1 – Tax Rate)

= 5% x (1 – 0.40)

= 5% x 0.60

= 3%

Cost of Preferred Stock

Cost of Preferred Stock = (Annual Preferred Dividend / Share Price) x 100

= ($2.00 / $15.00) x 100

= 13.33%

Cost of Common Stock

Cost of Common Stock = Risk-Free Rate + Beta(Market Return – Risk-Free Rate)

= 1.50% + 5(4% – 1.50%)

= 1.50% + (5 x 2.50%)

= 1.50% + 12.50%

= 14%

Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) = [After-tax Cost of Debt x Weight of Debt] + [Cost of Preferred Stock x Weight of Preferred Stock] + [Cost of Equity x Weight of Equity]

= (3% x 0.0404) + (13.33% x 0.7576) + (14% x 0.2020)

= 0.12% + 10.10% + 2.83%

= 13.05%

“Hence, the Weighted Average Cost of Capital (WACC) would be 13.05%”

jeff jeffy answered 1 year ago
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