Question

Preston Corp. is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent...

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.

Homework Answers

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%

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