Question

A firm’s optimal capital structure is 45% debt, 10% preferred stock, and 45% common equity. The firm’s tax rate is 43%. The beta coefficient of the firm’s debt is 0.2, the risk-free rate of interest is 2.7% and the market risk premium (RM-RF) is 7.3%. The firm’s preferred stock currently has a price of $84 and it carries a dividend of $10 per share. Currently, the price of a share of common equity was $29 per share. The last dividend payment is $2.52. Dividends are expected to grow at a rate of 4 percent for the future. What is this firm’s weighted average cost of capital? Select the best answer. Group of answer choices 0 percent 5 percent 10 percent 15 percent 20 percent

Answer #1

Calculation of :

Cost of debt = Risk free rate of return + beta coff ( market risk premium)

= 2.7 % + 0.2 * 7.3 %

= 2.7 % + 1.46%

= 4.16 %

Cost of preffered stock = Dividend / Price * 100

=10/84 * 100 = 11.90476%

Cost of equity = last dividend ( 1 + Groth rate) / Price + growth rate

= 2.52(1+0.04)/29 + 0.04

= 0.090372 + 004

= 0.130372 or 13.0372 %

Weighted average cost of capital = 4.16 * 45% + 11.90476*10% + 13.0372 *45%

= 8.9292 %

Percent of capital structure:
Debt
35
%
Preferred stock
20
Common equity
45
Additional information:
Bond coupon rate
11%
Bond yield to maturity
9%
Dividend, expected common
$
5.00
Dividend, preferred
$
12.00
Price, common
$
60.00
Price, preferred
$
120.00
Flotation cost, preferred
$
3.80
Growth rate
8%
Corporate tax rate
40%
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