Question

City Rentals has 44,000 shares of common stock outstanding at a market price of $32 a share. The common stock just paid a $1.50 annual dividend and has a dividend growth rate of 2.5 percent. There are 7,500 shares of $9 preferred stock outstanding at a market price of $72 a share. The outstanding bonds mature in 11 years, have a total face value of $825,000, a face value per bond of $1,000, and a market price of $989 each, and a pretax yield to maturity of 8.3 percent. The tax rate is 35 percent. What is the firm's weighted average cost of capital?

Answer 1

Value of Stock = Market price * no of shares outstanding = 32 * 44,000 = 1,408,000
Cost of stock = Dividend * ( 1+ growth )/Price + growth = 1.5 * ( 1+ 2.5%)/ 32 + 2.5% = 7.3046875%

Value of Preferred stock = No of prefered share * market price = 7500 * 72 = 540,000
Cost of Preferred stock = 9/72 = 12.5%

Value of Debt = Market Price * no of bonds = 989 * 825000/1000 = 815,925
Cost of Debt = 8.3%
Total Value = Equity + Debt + Preferred stock =  1,408,000 + 815,925 + 540,000 = 2763925

WACC = Equity/Total Value* Cost of Equity + Preferred Stock/Total Value * Cost of preferred stock + Debt/Total value * Cost of debt * ( 1 - Tax rate) = (1,408,000/2763925)*7.3046875% + (540,000/2763925)* 12.5% +
(815,925 /2763925) * 8.3% * ( 1- 35%) = 7.76%

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