Question

# Consider the following capital structure for AAA Corporation. The company has one debt issue, preferred stock...

Consider the following capital structure for AAA Corporation. The company has one debt issue, preferred stock and common stock in its capital structure. The firm’s tax rate is 40%; the risk-free rate is 3%.

Details on the components of the capital structure are listed below.

Bond issue:

Preferred equity:

Common equity:

Coupon-paying issue
\$100 million par
10% semiannual coupon
Remaining maturity of 15 years
Currently priced in market at 90% of par value

Coupon-paying issue
\$50 million par
6% annual coupon
Currently priced to yield 12%

2 million shares outstanding Current share price: \$50 Stock’s beta: 1.5

8.) What is AAA’s cost of debt?

9.) What is the total market value of AAA’s preferred stock?

10.) What is AAA’s weighted average cost of capital?

 Value Weight Cost Debt 90 41.9% 11.41% Preferred 25 11.6% 12.00% Equity 100 46.5% 14.25% Total 215 WACC 10.89%

Cost of debt can be calculated using I/Y function on a calculator

N = 15 x 2 = 30, PMT = 10% x 1000 / 2 = 50, PV = -900, FV = 1000 => Compute I/Y = 5.70% (semi-annual)

Annual cost of debt = 5.70% x 2 = 11.41%

Market Value of preferred stock = 50 x 6% / 12% = 25 million

WACC = 41.9% x 11.41% x (1 - 40%) + 11.6% x 12% + 46.5% x 14.25% = 10.89%

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