Question

What is a firm's weighted - average cost of capital if the stock has a beta of 1.25, Treasury bills yield 4%, and the market portfolio offers an expected return of 13%?

Debt that has a yield to maturity of 8.5%. The firm is in the 30% marginal tax bracket. The cost of preferred stock is 8%.

The following are the market values of debt $5 million, preferred stock $3 million. The book value of common stock is $10 million with 1,000,000 shares. The current market price of common stock is $15 per share.

Find the WACC.

Answer 1

Cost of equity (re) = Risk free rate + beta (Market rate - risk free rate)

= 4% + 1.25 (13% - 4%)

= 4% + 11.25%

= 15.25%

Cost of debt (rd) = 8.5%

Cost of preferred stock (rp) = 8%

WACC = re * equity percentage + rd * debt percentage (1-tax rate) + rp* preferred stock percentage

Total value of equity and debt = Market value of equity + market value of debt + market value of preferred stock

= ($15 * 1000000) + $5000000 + $3000000

=$23000000 or $23m

Percentage of equity = $15 / $23 = 65.22%

Percentage of debt = $5 / $23 = 21.74%

Percentage of equity = $3 / $23 = 13.04%

Now, putting the values into WACC equation, we get,

WACC = (15.25% *65.22%) + (8.5%* 21.74%) *(1-30%) + (8% * 13.04%)

= 12.28%