Question

Duffy Enterprises has issued common stock, preferred stock, and debt to finance its operation. The table...

Duffy Enterprises has issued common stock, preferred stock, and debt to finance its operation. The table below shows financial information on the firm.

2018 Balance Sheet:
Interest bearing debt $555,635.00
Preferred stock $47,428.00
Shareholder equity $750,000.00

Duffy has publicly traded common stock that has a capitalization currently of $1,710,860.00.

An analyst has estimated that the cost of debt for Duffy is 6.00%, the cost of the preferred stock is 10.00%, and the cost of the common equity is 14.00%. Duffy has a marginal tax rate of 35.00%.

a) What is the weight in common stock for Duffy?

b) What is the cost of capital for Duffy?

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Answer #1

a)

Total Firm value = Value of Common stock + Value of debt + Value of preferred equity
=1710860+555635+47428
=2313923
Weight of Common stock = Value of Common stock/Total Firm Value
= 1710860/2313923
=0.7394

b

Weight of debt = Value of debt/Total Firm Value
= 555635/2313923
=0.2401
Weight of preferred equity = Value of preferred equity/Total Firm Value
= 47428/2313923
=0.0205
After tax cost of debt = cost of debt*(1-tax rate)
After tax cost of debt = 6*(1-0.35)
= 3.9
WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)
WACC=3.9*0.2401+14*0.7394+10*0.0205
WACC% = 11.49
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