Question

Ace Company has the following capital structure. They issued 3,250 bonds that currently sell for 101.25 with a coupon rate of 5% that mature in 9 years. They also issued 12,000 shares of 8% preferred stock at $90, which currently sells for $85. The market return is expected to be 13% and the company’s beta is 1.25 with a risk‐free rate of 7%. They sold 225,000 shares of common stock that currently sells for $17.50. The company has a 21% tax rate. Please calculate the company’s WACC.

Answer 1

WACC = weight of bond * (1 - tax rate) * cost of debt + weight of preferred stock * cost of preferred stock + weight of equity * Cost of equity.

market value of bond = 3250 * 101.25 = 329062.5

Market value of preferred stock = 1020000

market value of equity = 3937500

Cost of preferred stock = 7.2/85 = 8.47%

Cost of equity = risk free rate + beta * (market return - risk free rate)

= 7% + 1.25 * (13 - 7)%

= 14.5%

Cost of debt = 4.83%

tax rate = 21%

Total value = mv of debt + mv of preferred stock + mv of bond

= 5286562.5

weight of debt = 6.22%

weight of equity = 74.48%

weigh of preferred stock = 19.30%

WACC = 0.0622 * 4.83%*(1 - .21) + .7448 * 14.5% + .193 * 8.47%

= 12.67%