Question

# The capital structure of Jolly Jellybeans Corp. is as follows: Debt: 40% Preferred stock: 10% Common...

The capital structure of Jolly Jellybeans Corp. is as follows:

Debt: 40%

Preferred stock: 10%

Common stock: 50%

 Price of common stock \$35 Dividend (common stock) \$1.25 Growth rate (common stock) 5% Price (preferred) \$80 Dividend (preferred) \$6.25 Flotation cost (preferred) \$2.00 Bond YTM 8% Corporate tax rate 25%

Compute Jolly’s WACC.

(a)  %

The cost of equity is :

Re = D1/Po + g

= \$1.25 * 1.05/ \$35 + 0.05 ( assuming the dividend paid to be D0)

= 8.75%

The cost of preference capital is :

= Dividend paid/ price of preference share

= \$6.25 / \$80 - \$2

= 8.01%

The after tax cost of debt is :

= 8% * (1 - 0.25)

= 6%

So, the WACC is :

weight of debt * after tax cost of debt + weight of equity * cost of equity + weight of preference * cost of preference

= 0.4* 0.06 + 0.5* 0.0875 + 0.1* 0.0801

= 0.024 + 0.0438 + 0.008

=7.58%

So, the WACC is 7.58%

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