Question

1. Phiri Plastics is trying to estimate their cost of capital. They have gathered the following information:  Phiri’s tax rate is 25%  Investors expect earnings and dividends to grow at a constant rate of 6%  Phiri paid dividends of $3.70 per share to common stockholders last year  Treasury bonds currently yield 6%  The average return in the market is 11%  Phiri’s beta is 1.3  Phiri’s preferred stock pays a 9% dividend on a par value of $100  Phiri’s bonds have a 7% coupon rate on a $1000 par value and mature in 8 years  The current price of Phiri’s common stock is $60  The current price of Phiri’s preferred stock is $95  The current price of Phiri’s bonds is $889.30  Phiri’s capital structure is 25% debt, 15% preferred stock, and 60% common stock a. Calculate the component cost of debt. b. Calculate the component cost of preferred stock. c. Calculate the component cost pf common stock. d. Calculate the weighted average cost of capital.

Please break down step by step.

Answer 1

Weighted average cost of capital (WACC)=(weight of equity*cost of equity)+(weight of preferred stock*cost of preferred stock)+(weight of debt*after tax cost of debt)

Cost of equity=risk free rate+(beta*(market return-risk free rate))

risk free rate=treasury bonds yield=6%

Cost of equity=6%+(1.3*(11%-6%))=12.5%

Cost of preferred stock=annual dividend/preferred stock price=(9%*100)/95=9/95=9.47%

Pre tax cost of debt can be found by using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

nper=maturity time=8

pmt=coupon payment=7%*1000=70

pv=889.30 (current price of the bond)

fv=1000 (face value)

=RATE(8,70,-889.30,1000,0)

RATE=9%

Pre tax cost of debt=9%

After tax cost of debt=Pre tax cost of debt*(1-tax rate)=9%*(1-25%)=6.75%

Weighted average cost of capital (WACC)=(60%*12.5%)+(15%*9.47%)+(25%*6.75%)=10.61%