A Company finances its projects with 40% debt, 10% preferred stock, and 50% common stock

Business Oct 06, 2020

A Company finances its projects with 40% debt, 10% preferred stock, and 50% common stock.

- The company can issue bonds at a YTM of 8.4%.
- The cost of preferred stock is 9%.
- The risk-free rate is 6.57%.
- The market risk premium is 5%.
- Johnson Industries' beta is equal to 1.3.
- Assume that the firm will be able to use retained earnings to fund the equity portion of its capital budget.
- The company's tax rate is 30%.

What is the company's WACC?

Expert Solution

Step I Find out Ke:
Ke = Rf+b(Km-Rf)=13.07%

Ke= Cost of Equity capital

Rf= Risk free Rate=6.57%
Km-KF = Market risk premium=5.00%
b=beta coefficient=1.3

Thus here cost of equity =6.57%+1.3*(5%)= 13.07%

The solution should be WACC=Wd(Rd) + Wps(Rps) + Wce(Rs)
.4(5.88%) + .1(9%) + .5*(13.07%) =9.79%

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