Question

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) %

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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Debt
10
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Preferred stock
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Common equity
85
Additional information:
Bond coupon rate
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Bond yield to maturity
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Dividend, expected common
$
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Dividend, preferred
$
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Price, common
$
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Price, preferred
$
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Flotation cost, preferred
$
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Corporate tax rate
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Preferred stock
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Dividend, preferred
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Corporate tax rate
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Common
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