Question

Lowell Publishing has a cost of debt of 6.6%, a cost of equity of 13.4%, and a cost of preferred stock of 8.5%. The firm has 260,000 shares of common stock outstanding at a market price of $50 a share. There are 30,000 shares of preferred stock outstanding at a market price of $40 a share. The bond issue has a total face value of $10,000,000 and sells at 104% of face value. The tax rate is 25%. What is the weighted average cost of capital for Lowell Publishing? (Hint: use the bond price to calculate the market value of debt)

		10.42%
		10.13%
		9.81%
		9.59%
		9.27%

Answer 1

Market Value of Equity = Number of common stocks * Market Price = 260000 * 50 = $13000000

Market Value of Preferred Stock = Number of Preferred shares * Market Price = 30000 * 40 = $ 1200000

Market Value of Debt = Face Value * Selling Price = 10000000 * 104% = $10400000

Total Value of Equity + Preferred + Debt = 13000000 + 1200000 + 10400000 = $24600000

% Equity w_e = 13000000/24600000

% Preferred w_p = 1200000/24600000

% Debt w_d = 10400000/24600000

Cost of equity = r_e = 13.4%

Cost of preferred stock = r_p = 8.5%

Cost of debt = r_d = 6.6%

Tax Rate = 25%

WACC = w_er_e + w_pr_p + w_dr_d(1-t)

= (13000000/24600000)*13.4 + (1200000/24600000)*8.5 + (10400000/24600000)*6.6*(1-0.25)

= 9.59%

Hence, option (d) 9.59% is correct option