If a company finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock

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If a company finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock.

1) The company can issue bonds at a yield to maturity of 8.4 percent.
2) The cost of preferred stock is 9 percent.
3) The company's common stock currently sells for $30 a share.
4) The company's dividend is currently $2.00 a share (D0 = $2.00), and is expected to grow at a constant rate of 6 percent per year.
5) Assume that the flotation cost on debt and preferred stock is zero, and no new stock will be issued.

The company's tax rate is 30 percent.

What is the company=s weighted average cost of capital (WACC)?

WACC is the weighted average cost of capital whereby the target proportions of debt and equity along with the component costs of capital are used to calculate. The equation can be summarized as follows: -

WACC = WdKd(1 - T) + WpKp + WcKs where Wd is the weight of debt
Kd is the cost of debt
T is the tax rate
Wp is the weight of preferred stock
Ks is the cost of preferred stock
Wc is the weight of common stock
Ks is the cost of common stock

We have been given information of nearly everything except for the cost of common stock. We need to use constant growth method to figure out the cost of common stock as follows: -

P = D0(1 + g) where D0 is the dividend this year
(k - g) k is the required rate of return
g is the growth rate
P is the current stock price

30 = 2(1 + 0.06)
(k - 0.06)

30k - 1.8 = 2.12

30k = 3.92

k = 13.07%

Then, we can replace the information given into the equation to find WACC.

WACC = WdKd(1 - T) + WpKp + WcKs
= [0.40 x 0.084(1 - 0.30)] + (0.10 x 0.09) + (0.50 x 0.1307)
= 0.02352 + 0.009 + 0.06535
= 0.09787 or 9.79%