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AA corporation has a capital structure consisting of 40% debt, 10% preferred stock, and 50% common...

AA corporation has a capital structure consisting of 40% debt, 10% preferred stock, and 50% common equity. Assume the firm has a sufficient retained earnings to fund the equity portion of its capital budget. It has 20-year, 14% semiannual coupon bonds that sell at their par value of $1,000. The firm could sell, at par, $50 preferred stock that pays a 8% annual dividend. AA’s beta is 1.4, the risk-free rate if 5%, and the market risk premium is 8%. AA is a constant growth firm that just paid dividend of $1.00, sells for $20.00 per share, and has a growth rate of 10%. AA’s tax rate is 30%. what is AA’s WACC?

i need specific calculation process for this question, not only the answer!!

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Expert Solution

Cost of Debt: Bond Tenure = 20 years, Coupon Rate = 14 % payable semi-annually,Par Value = $ 1000, Market Price = Par Value = $ 1000, As the bond sells at par, the bond's annual coupon rate should equal its yield to maturity.

Therefore, Bond Coupon = Yield to Maturity = 14 %

Cost of Debt = Yield to Maturity = 14 %

Cost of Preferred Stock: Par Value of Preferred Stock = $ 50, Annual Dividend Rate = 8% of par, Current Price = Par Value = $ 50
Annual Dividend = 0.08 x 50 = $ 4

Cost of Preferred Stock = 4/50 = 0.08 or 8 %

Cost of Common Stock:

Method 1

Risk-Free Rate = Rf = 5%, Market Risk Premium = MRP = 8%, Beta = 1.4

Cost of Common Stock 1 = Rf + MRP x Beta = 5 + 1.4 x 8 = 16.2 %

Method 2

Current Dividend = D0 = $ 1, Current Price = P0 = $ 20 and Growth Rate = g = 10%

Expected Dividend = D1 = D0 x (1+g) = 1 x 1.2 = $ 1.2

Cost of Common Stock 2 = (D1/P0) + g = (1.2/20) + 0.1 = 0.16 or 16 %

Average Cost of Common Stock = (16,2+16) / 2 = 16.1 %

Capital Structure: Common Equity(Stock) = 50%, Preferred Stock = 10% and Debt = 40 %

Tax Rate = 30 %

WACC = 0.4 x (1-0.3) x 14 + 0.5 x 16.1 + 0.1 x 8 = 12.77 %

jeff jeffy answered 1 year ago
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