Question

Hatch Corporation’s target capital structure is 52 percent debt, 12 percent common stock, and 36 percent preferred stock. Information regarding the company’s cost of capital can be summarized as follows: · The company’s bonds have a nominal yield to maturity of 6.7 percent. · The company’s preferred stock sells for $35 a share and pays an annual dividend of $3 a share. · The company’s common stock sells for $25 a share, and is expected to pay a dividend of $2 a share at the end of the year (i.e., D1 = $2). The dividend is expected to grow at a constant rate of 6 percent a year. · The firm will be able to use retained earnings to fund the equity portion of its capital budget. · The company’s tax rate is 30 percent. What is the company’s weighted average cost of capital (WACC)?

Group of answer choices 6.80% 7.20% 7.00% 7.60% 7.40%

Answer 1

The WACC is computed as shown below:

= cost of debt x (1 - tax rate) x weight of debt + cost of common stock x weight of common stock + cost of preferred stock x weight of preferred stock

cost of preferred stock is computed as follows:

= Annual dividend / Price per share

= $ 3 / $ 35

= 8.571428571% or 0.08571428571

cost of common equity is computed as follows:

= (D1 / current stock price) + growth rate

= ($ 2 / $ 25) + 0.06

= 14% or 0.14

So, the WACC is computed as follows:

= 0.067 x (1 - 0.30) x 0.52 + 0.14 x 0.12 + 0.08571428571 x 0.36

= 0.024388 + 0.0168 + 0.030857143

= 7.20% Approximately

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