Question

The yield to maturity on Dasman’s bond is 9 percent. Dasman’s preferred stock is priced at $35 with a flotation cost of $1, and its annual preferred dividend payment is $5 per share. Dasman Company’s expected dividend at the end of the year is $1.60 on its common stock and this dividend is expected to grow at a constant rate of 7% for ever. The company is going to issue new common stock at a price of $40 per share with a $2 flotation cost. This company has a marginal tax rate of 30%. What is the weighted average cost of capital (WACC) of Dasman, if the capital structure is made up of 30 percent debt, 20 percent preferred stock, and 50 percent common equity?

Select one:

a. 9.45 percent

b. 10.20 percent

c. 10.40 percent

d. 11.20 percent

e. 10.70 percent

You have a portfolio consisting solely of stock A and stock B. The portfolio has an expected return of 10.2 percent. Stock A has an expected return of 12 percent while stock B is expected to return 7 percent. What is the portfolio weight of stock A?

Select one:

a. 64 percent

b. 54 percent

c. 58 percent

d. 46 percent

e. 70 percent

show me how you got it

Answer 1

Solution :-

Cost of Bond ( kd ) = 9% * ( 1 - 0.30 ) = 6.3%

Cost of Preferred Stock ( kp ) = Dividend / ( Price - Flotation Cost ) = $5 / ( $35 - $1 ) = 0.1471 = 14.71%

Cost of Equity ( ke ) = [ D1 / P0 ] + g = [ $1.60 / $38 ] + 0.07 = 0.1121 = 11.21%

Weight of Bond ( Wd ) = 0.30

Weight of Preferred Stock ( Wp ) = 0.20

Weight of Equity ( We ) = 0.50

WACC = ( We * Ke ) + ( Wp * Kp ) + ( Wd * Kd )

= ( 0.50 * 11.21% ) + ( 0.20 * 14.71% ) + ( 0.30 * 6.3% )

= 10.40%

Therefore Correct Answer is (C)

Solution :- ( 2 )

Let ER of Stock A = 12%

ER of Stock B = 7%

Weight of Stock A = X

Therefore Weight of Stock B = ( 1 - X )

Portfolio Expected Return = 10.2%

( X * 12% ) + 7% * ( 1 - X ) = 10.2%

12% X + 7% - 7% X = 10.2%

5% X = 3.2%

X = 0.64 = 64%

Weight of Stock A = 64%

Therefore Correct Answer is (A)

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