Question

The expected return on the market is 16.52 percent, the risk-free rate is 5.37 percent, and the tax rate is 45 percent. Fairfax Paint has 1,200,000 common shares outstanding that are priced at 20 dollars per share and have an expected return of 18.96 percent and an expected real return of 17.16 percent. Last year, Fairfax Paint common stock had a return of 20.47 percent. The company also has 800,000 shares of preferred stock outstanding that are priced at 15 dollars per share and have an expected return of 11.49 percent and an expected real return of 9.8 percent. Last year, Fairfax Paint preferred stock had a return of 14 percent. Finally, the company has 10,000 bonds outstanding with a coupon rate of 7.06 percent, yield-to-maturity of 3.36 percent, current yield of 5.43 percent, face value of 1000 dollars, and price of 1,300 dollars. What is the weighted average cost of capital for Fairfax Paint? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

Expected Cost of Equity = 18.96%

Expected Cost of Debt after tax = 3.36% (1- 0.45) = 1.848%

Cost of Preferred Stock = 11.49%

Equity Capital = 1,200,000 * 20 = 24,000,000

Debt Capital = 10,000 * 1300 = 13,000,000

Preferred Capital = 800,000 * 15 = 12,000,000

Total Capital = 24,000,000 + 13,000,000 + 12,000,000 = 49,000,000

weight of Equity =  24,000,000 / 49,000,000 = 48.98%

weight of Debt =  13,000,000 / 49,000,000 = 26.53%

weight of Preferred  =  12,000,000 / 49,000,000 = 24.49%

WACC = (Cost of Equity * Weight of Equity) + (Cost of Debt after tax * Weight of Debt) + (Cost of Preferred Stock * Cost of Preferred Stock)

=  18.96% * 0.4898 + 1.848% * 0.2653 + 11.49% * 0.2449

= 12.59%