Question

# Preston Corp. is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent...

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?

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%

the above will be the answer..