Question

The Oriole Products Co. currently has debt with a market value of $275 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,429.26 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $14 per share. The preferred shares pay an annual dividend of $1.20. Oriole also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 4 percent per year forever. If Oriole is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?

a) Calculate the weights for debt, common equity, and preferred equity. (Round intermediate calculations and final answers to 4 decimal places, e.g. 1.2514.)

Debt
Preferred equity
Common equity

b) Calculate the cost of debt. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Cost of debt

%

c) Calculate the cost of preferred equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Cost of preferred equity

d) Calculate the cost of common equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 0 decimal places, e.g. 15%.)

Cost of common equity

e) What is the firm’s weighted average cost of capital? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

WACC

Answer 1

Market Value of debt = $275 million

Market Value of Equity = $ 14*20 million = $ 280 million

Market Value of Preferred shares = $ 14*2 million = $ 28 million

Total Capital = 275 + 280 + 28 = $ 583 million

The weight for debt = Debt/Total Capital = 275/583 = 0.4717

Weight for Equity = 280/583 = 0.4803

Weight for Preferred shares = 28/583 = 0.048

b.

Cost of debt = Int(1 - tax rate) = 9 * .6 = 5.4%

c.

Cost of preferred Equity = Dividend/Market Price = 1.2/14 = 8.57%

d.

The cost of Equity can be calculated by the dividend discount model.

Ke = Dividend to be paid next year/Current market Price + growth rate

=2.2/20 + 0.04

=0.15 = 15%