Question

Please solve this question:

The Standard and Poor’s index retuned 8% in 1993 when treasury rates were 2%. Hall Industries had a beta of 1.12. Hall Industries also has two bonds outstanding in equal amounts that yield 3% and 4% respectively. Hall Industries also has a preferred stock that yields 5%. The following weights are stocks 50%, bonds 20% and 20% and the preferred stock 10%. What is the Weighted Average Cost of Capital for Hall industries in1993 if taxes are .32%.

Answer 1

As per CAPM

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

Expected return% = 2 + 1.12 * (8 - 2)

Expected return% = 8.72

cost of debt =sum of weight of debt*cost of debt = 0.5*3+0.5*4 = 3.5%

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 3.5*(1-0.32)

'= 2.38

Weight of equity = E/A

Weight of equity =

W(E)=0.5

Weight of debt = D/A

Weight of debt = 0.4

W(D)=0.4

Weight of preferred equity =1-D/A-E/A

Weight of preferred equity = =1-0.4 - 0.5

W(PE)=0.1

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=2.38*0.4+8.72*0.5+5*0.1

WACC% = 5.81