Question

Problem 11-23 Weighted average cost of capital [LO11-1]

Given the following information:

Percent of capital structure:

Preferred stock	20	%
Common equity	60
Debt	20

Additional information:

Corporate tax rate		40	%
Dividend, preferred	$	11.00
Dividend, expected common	$	6.50
Price, preferred	$	107.00
Growth rate		9	%
Bond yield		8	%
Flotation cost, preferred	$	7.50
Price, common	$	91.00

Calculate the weighted average cost of capital for Digital Processing Inc. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
  
debt_______%

preferred stock_____________

common equity_____________

weighted average of cost of capital_____________

Answer 1

Weight of equity = E/A

Weight of equity =

W(E)=0.6

Weight of debt = D/A

Weight of debt = 0.2

W(D)=0.2

Weight of preferred equity =1-D/A-E/A

Weight of preferred equity = =1-0.2 - 0.6

W(PE)=0.2

Cost of equity

As per DDM

Price= Dividend in 1 year/(cost of equity - growth rate)

91 = 6.5/ (Cost of equity - 0.09)

Cost of equity% = 16.14

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 8*(1-0.4)

= 4.8

cost of preferred equity

cost of preferred equity = Preferred dividend/price-flotation cost*100

cost of preferred equity = 11/(99.5-7.5)*100

=11.06

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=4.8*0.2+16.14*0.6+11.06*0.2

WACC =12.86%