Question

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 7.74 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?

NOTE: Please DO NOT use Excel. Show me how to do with calculator.

Answer 1

Cost of Debt=YTM
Using financial calculator
N=20*2
PV=-1100
PMT=12%*1000/2
FV=1000
CPT I/Y=5.38610%

YTM=5.38610%*2=10.77219%

Cost of preferred stock=Preferred Dividend/(Preferred stock price*(1-flotation cost%))=7.74%*100/(100*(1-5%))=8.14737%

Cost of common stock=risk free rate+beta*market risk premium=3%+1.2*5%=9.00000%

WACC=proportion of debt*ytm*(1-tax rate)+proportion of preferred stock*cost of preferred stock+proportion of common stock*cost of common stock=20%*10.77219%*(1-40%)+20%*8.14737%+60%*9.00000%=8.32214%