Question

Preston Corp. is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sells for $1,100. The firm could sell, at par, $100 preferred stock which pays a 5.46 percent annual dividend, but flotation costs of 5 percent would be incurred. Preston's beta is 1.2, the risk-free rate is 3 percent, and the market risk premium is 5 percent. The firm's marginal tax rate is 40 percent. What is Preston's WACC?

Answer #1

cost of equity=risk free rate+beta*market risk premium

=3%+1.2*5%

=9%

cost of preferred stock=annual dividend/(price-floation cost)

=(100*5.46%)/(100-100*5%)

=5.75%

cost of debt using excel function=RATE(nper,pmt,pv,fv)

=(RATE(20*2,1000*12%/2,-1100,1000))*2

=10.77%

cost of debt after tax=10.77%*(1-40%)

What is Preston's WACC

=Weight of equity*cost of equity+weight of preferred stock*cost of preferred stock+weight of debt*cost of debt*(1-tax rate)

=60%*9%+20%*5.75%+20%*6.46%

=7.84% (answer)

the above will be the answer..

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