Question

XYZ Industries has 6.5 million shares of common stock outstanding with a market price of $14 per share. The company also has outstanding preferred stock with a market value of $10 million, and 25,000 bonds outstanding, each with face value $1,000 and selling at 90% of par value. The cost of equity is 14%, the cost of preferred is 10%, and the cost of debt is 7.25%. If XYZ's tax rate is 34%, what is the WACC? A) 9.5% B) 10.0% C) 10.8% D) 11.6% E) 12.0%

Answer 1

Suction :

Market value of equity = Share price * number of shares = $14 * 6.5 million = $91 million

Market value of preferred share = $10 million

Market value of bonds = number of bonds * market price of the bond = 25000 * 90% *1000 = 22,500,000

Total value of equity, preferred and debt is = 91 million + 10 million + 22.5 million = $123.5 million

Weight of equity = 91/123.5 = 73.68%

Weight of preferred share =10/123.5 = 8.10%

Weight of debt = 22.5/123.5 = 18.22%

Cost of equity = 14%

Cost of preferred = 10%

After tax cost of debt = 7.25% * (1-0.34) = 4.785%

WACC = sum of ( weight of respective asset * cost of assets)

WACC = 73.68% * 14% + 8.10% * 10% + 18.22% * 4.785% = 12%

Hence correct option is E ) 12%