Question

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.]

Answer #1

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% |

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...

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...

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$1.50 each. The company's bonds have a total market value of
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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
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