Question

Lexington Corporation has a cost of debt of 7.2%, a cost of equity of 14.6%, and a cost of preferred stock of 9.4%. The company has 285,000 shares of common stock outstanding at a market price of $50 a share. There are 15,000 shares of preferred stock outstanding at a market price of $40 a share. The bond issue has a total face value of $16,000,000 and sells at 101% of face value. The tax rate is 25%. What is the weighted average cost of capital for the company? (Hint: use the bond price to calculate the market value of debt)

A.8.96%

B.9.92%

C.9.33%

D.9.71%

E.8.78%

Answer 1

Common stock = 285,000 * $50 = $14,250,000

Preferred stock = 15,000 * $40 = $600,000

Debt = $16,000,000 * 1.01 = $16,160,000

Total value = $14,250,000 + $600,000 + $16,160,000 = $31,010,000

WACC = (Weight of common stock * Cost of common equity) + (Weight of preferred stock * Cost of preferred stock) + [Weight of debt * Pretax cost of debt(1 - Tax)]

WACC = [($14,250,000/$31,010,000) * 0.146] + [($600,000/$31,010,000) * 0.094] + [($16,160,000/$31,010,000) * 0.072(1 - 0.25)]

WACC = 0.0971 or 9.71%