Question

Mercado, Inc. has 5,400,000 common shares outstanding at a price of $ 64 each. He has 290,000 preferred shares outstanding with a 5.6% dividend based on the par value of $ 100, which sell for $ 103 each. It has issued 125,000 bonds at 109% of their par value of $ 1,000, with a yield to maturity of 5.93%. The common share's beta is 1.13, the treasury bills rate is 4.3%, and the market risk premium is 6.8%. The applicable tax rate is 34%.

The company's weighted average cost of capital (wacc) is
Select one:

a. 7.09%
b. It cannot be calculated with the expected information.
c. 9.45%
d. 10%

Answer 1

C) 9.45%

explanation:

Investment in equity= 5,400,000 × 64 = 345,600,000

Investment in preference share= 290,000 × 103 = 29,870,000

Investment in debt= 125,000 × 1,090 = 136,250,000

Total investment = 511,720,000

Weight of equity= 345,600,000 / 511,720,000 = 0.6754

Weight of preference = 29,870,000 / 511,720,000 = 0.0584

Weight of debt = 136,250,000 / 511,720,000 = 0.2663

Cost of preference share = annual dividend / current share price

= 5.6 / 103

= 5.54%

Cost of equity= Risk free rate + beta (market risk premium)

= 4.3% + 1.13 × 6.8%

= 4.3% + 7.684%

= 11.984%

Wacc = weight of debt × cost of debt (1-tax) + weight of preference × cost of preference share + weight of equity × cost of equity

= 0.2663 × 5.93% (1-0.34) + 0.0584 × 5.44% + 0.6754 × 11.984%

= 0.2663 × 5.93% (0.66) + 0.317696% + 8.094%

= 0.2663 × 3.9138% + 0.317696% + 8.094%

= 1.0422% + 0.317696% + 8.094%

= 9.45%