Question

# A company has 3 million shares outstanding at a market price of \$1.50 each. The company's...

A company has 3 million shares outstanding at a market price of \$1.50 each. The company's bonds have a total market value of \$2,700,000, have a coupon rate of 3% p.a. and currently yield 4% p.a. The current market value of preference shares is \$500,000 and currently return 5% p.a. The company has a beta of 0.7, the market risk premium is 6% p.a., the risk-free return is 2% p.a., and the company tax rate is 30%,

What is the firm's weighted average cost of capital (WACC)?

[Be sure to show the calculation of each part of the WACC, and the final value for the WACC.]

Calculation of weights of the each component in WACC :-

 Particulars market value weight ( market value of component / total value) Debt 2,700,000 0.3507 ( 2,700,000/ 7,700,000) Preferred stock 500,000 0.0649 (500,000/ 7,700,000) Common stock 4,500,000 0.5844 ( 4,500,000 / 7,700,000) Total value 7,700,000 1

Calculation of the cost of debt after tax :-

Cost of debt after tax = yield on bond * ( 1- tax rate)

= 4% * (1 - 0.30)

Cost of debt after tax = 2.8%

Cost of preferred stock = return on preferred stock = 5%

Calculation of the cost of equity :-

Cost of equity = Rf + Beta * market risk premium

= 2% + 0.7 * 6%

Cost of equity = 6.2%

Calculation of weighted average cost of capital (WACC) :-

 Particulars cost weights WACC Debt 2.8% 0.3507 0.98196% Preferred stock 5% 0.0649 0.3245% Equity 6.2% 0.5844 3.62328% WACC 4.92974%

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