Question

Johnson Industries finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock.
 The company can issue bonds at a yield to maturity of 8.4 percent.
The cost of preferred stock is 9 percent.
The company's common stock currently sells for $30 a share.
The company's dividend is currently $2.00 a share (D0 = $2.00), and is expected to grow at a constant rate of 6 percent per year.
The company’s tax rate is 30 percent.
What is the company’s weighted average cost of capital (WACC)?

Answer 1

g = growth rate = 6%

D0 = $2.00

D1 = D0*(1+g) = $2.00 * (1+6%) = $2.12

Current share price = D1/(Ke - g)

$30 = $2.12 / (Ke - 6%)

Ke-6% = 0.07066667

Ke = 0.13066667

Cost of equity = ke = 13.07%

Yeild to maturity = rd = 8.4%

Cost of Preferred stock = rp = 9%

Weight of Common stock = We = 50%

Weight of Debt = Wd = 40%

Weight of Preferred Stock = Wp = 10%

t = tax rate = 30%

Weighted Average Cost of Capital = [We*ke] + [Wp*rp] + [Wd*rd*(1-t)]

= [50%*13.07%] + [10%*9%] + [40%*8.4%*(1-30%)]

= 6.535% + 0.9% + 2.352%

= 9.787%

Therefore, Company's Weighted Average Cost of Capital is 9.79%