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%

Additional information about the company is also given:

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.

(Hint: Start with computing the costs of each component in the capital structure.) State your answer as xx.xx% (for example 13.65%)

Answer:

(a)  %

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Homework Answers

Answer #1

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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