Question

) LEI has the following capital structure, which it considers to be optimal:

Debt 25%
Preferred stock 15%
Common equity 60 %
100 %

LEI’s tax rate is 40% and investors expect earnings and dividends to grow at a
constant rate of 9% in the future. LEI paid a dividend of $3.60 per share last year,
and its stock currently sells at a price of $54 per share.
LEI can obtain new capital in the following ways:
Preferred: New preferred stock with a dividend of $11 can be sold to the public at
a price of $95 per share.
Debt: Debt can be sold at an interest rate of 12%.
Calculate the Weighted average cost of capital (WACC). [7]

Answer 1

Cost of equity = (D1 / share price) + growth rate

Cost of equity = [(3.6 * 1.09) / 54] + 0.09

Cost of equity = 0.07267 + 0.09

Cost of equity = 0.16267 or 16.267%

Cost of preferred stock = (Annual dividend / share price) * 100

Cost of preferred stock = (11 / 95) * 100

Cost of preferred stock = 11.5790%

WACC = Weight of debt*after tax cost of debt + weight of preferred stock*cost of preferred stock + weight of common stock*cost of common stock

WACC = 0.25*0.12*(1 - 0.4) + 0.15*0.115790 + 0.6*0.16267

WACC = 0.018 + 0.01736 + 0.0976

WACC = 0.1330 or 13.30%