Question

Johnson Industries finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock. · The company can issue bonds at a yield to maturity of 7.6 percent. · The cost of preferred stock is 9 percent. · The company's common stock currently sells for $29 a share. · The company's dividend has just paid $2.00 a share (D0 = $2.00), and is expected to grow at a constant rate of 5 percent per year. · Assume that the flotation cost on debt and preferred stock is zero, and no new stock will be issued. · The company's tax rate is 30 percent. What is the company's weighted average cost of capital (WACC)? Express your answer in percentage (without the % sign) and round it to two decimal places.

Answer 1

Debt:

Weight of Debt = 40%

Annual YTM = 7.60%

Before-tax Cost of Debt = 7.60%
After-tax Cost of Debt = 7.60% * (1 - 0.30)
After-tax Cost of Debt = 5.32%

Preferred Stock:

Weight of Preferred Stock = 10%
Cost of Preferred Stock = 9.00%

Equity:

Weight of Common Stock = 50%

Expected Dividend = Recent Dividend * (1 + Growth Rate)
Expected Dividend = $2.00 * 1.05
Expected Dividend = $2.10

Cost of Common Equity = Expected Dividend / Current Price + Growth Rate
Cost of Common Equity = $2.10 / $29.00 + 0.05
Cost of Common Equity = 0.1224 or 12.24%

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Preferred Stock * Cost of Preferred Stock + Weight of Common Stock * Cost of Common Stock
WACC = 0.40 * 5.32% + 0.10 * 9.00% + 0.50 * 12.24%
WACC = 9.15%

Weighted average cost of capital of the company is 9.15%