Question

Emeka Industries can borrow funds at a 12 percent interest rate. Its preferred stock sells for $80/share and pays an annual dividend of $4/share. The company has a beta of 1.3, risk-free investments currently pay 2 percent. The company pays taxes at a 30 percent rate. The required rate of return for an average stock is 8 percent. Emeka’s Target Capital structure consists of 15 percent preferred stock, 40 percent debt, and 45% common equity. What is the Emeka’s WACC?

Answer 1

Emeka’s WACC

After-tax cost of capital = 8.40% [12.00% x (1 – 0.30)]

Cost of Preferred Stock = 5.00% [($4.00 / $80.00) x 100]

Cost of Equity = 9.80% [2.00% + 1.30(12.00% - 2.00%)]

Weight of Debt = 40% or 0.40

Weight of Preferred Stock = 15% or 0.15

Weight of Equity = 45% or 0.45

Therefore, the Weighted Average Cost of Capital (WACC) = [After-tax cost debt x Weight of Debt] + [Cost of Preferred stock x Weight of Preferred stock] + [Cost of Equity x Weight of Equity]

= [8.40% x 0.40] + [5.00% x 0.15] + [9.80% x 0.45]

= 3.36% + 0.75% + 4.40%

= 8.52%

Hence, Emeka’s WACC will be 8.52%