Question

Your company has a target capital structure of 40% debt, 15% preferred, and 45% common equity....

Your company has a target capital structure of 40% debt, 15% preferred, and 45% common equity. Your bonds carry a 9% coupon, have a par value of $1,000, and 7 years remaining until maturity. They are currently selling for $950.51. The cost of preferred is 7.50%. The risk free rate is 4%, the market risk premium is 8%, and beta is 1.0. The firm will not be issuing any new stock, and the tax rate is 40%. What is its WACC?

a. 6.69% b. 7.68% c. 8.93% d. 6.96% e. 7.59%

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Answer #1


Correct Answer is option C - 8.93%
WACC = Wd*kd + We*ke + Kp*Wp
We = Weight of equity
Wd = weight of debt
Wp = Weight of preference

Re = Rf + (Rm -Rf)*beta
Re = 4+ (8)*1
Re = 12%

To calculate the cost of debt, enter the stock in the financial calculator-
PV = -950.51
Fv = 1000
PMT = 90 (1000*9% = 90)
N = 7
CPT - I/Y = 10.02

Cost of debt afte tax = Interest (1-t)
Cost of debt after tax = 10.02 (1-0.40)
Cost of debt after tax = 6.012

Kd = 6.012%
Kp = 7.5%
Ke = 12%

WACC = Wd*kd + We*ke + Kp*Wp
WACC = 0.4*6.012 +0.45*12 + 0.15*7.5
WACC =8.93%

I hope this clear your doubt.

Feel free to comment if you still have any query or need something else. I'll help asap.

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