Question

ABC Industries has 5 million shares of common stock outstanding with a market price of $20.00 per share. The company also has 1 million shares outstanding preferred stock with a market price of $8.50 per share, and 200,000 bonds outstanding, each with a face vale $1,000 and selling at 97.5% par value. The cost of equity is 12%, the cost of preferred is 10%, and the cost of debt is 7.46%. If ABC's tax rate is 34% what is the WACC

Answer 1

Solution:         

Calculation of Market value of Common stock:

As per the information given in the question

No. of shares of common stock outstanding = 5 Million

Market price per share = $ 20 per share

Market value of common stock outstanding = 5 Million * $ 20 = $ 100 Million

Calculation of Market value of Preferred stock:

As per the information given in the question

No. of shares of preferred stock outstanding = 1 Million

Market price per share = $ 8.50 per share

Market value of preferred stock outstanding = 1 Million * $ 8.50 = $ 8.50 Million

Calculation of Market value of Debt:

As per the information given in the question

No. of bonds outstanding = 200,000

Market price per bond = Each with a face value $1,000 and selling at 97.5% par value

Thus market price of a bond with face value of $ 1000 = $ 1000 * 97.5 % = $ 975

Market value of bonds outstanding = 200,000 * $ 975 = 195,000,000 = 195 Million

Total Market value of the Securities = $ 100 Million + $ 8.5 Million + $ 195 Million = $ 303.5 Million

Thus Weight of Debt = [ Market value of debt / Total market value of all the securities ]

= $ 195 Million / $ 303.5 Million = 0.6425

Thus Weight of Preferred Stock = [ Market value of Preferred Stock / Total market value of all the securities ]

= $ 8.5 Million / $ 303.5 Million = 0.0280

Thus Weight of Common Stock = [ Market value of Common Stock / Total market value of all the securities ]

= $ 100 Million / $ 303.5 Million = 0.3295

The formula for calculating the weighted average cost of capital is =

WACC = [ K_D * ( 1 – t ) * W_D ] + [ K_P * W_P ] + [ K_C * W_C ]

K_D = Cost of debt    ; t = Income tax rate ; W_D = Weight of debt ;

K_P = Cost of Preferred Stock ; W_P = Weight of preferred stock    ;  

K_C = Cost of Common Stock     ;    W_C = Weight of common stock

As per the information available in the question we have

K_D = 7.46 %     ; t = 34 % = 0.34 ; W_D = 0.6425 ; K_P = 10 % ;    W_P = 0.0280     ;

K_C = 12 %    ;    W_C = 0.3295

Applying the above values in the formula we have

= [ ( 7.46 * ( 1 – 0.34 ) * 0.6425 ) + ( 10 * 0.0280 ) + ( 12 * 0.3295 ) ]

= [ 3.1634 + 0.2801 + 3.9539 ]

= 7.3974 %

= 7.40 % ( When rounded off to two decimal places )

Thus the weighted average cost of capital of the ABC Industries is 7.40 %