Why Choose Us?
0% AI Guarantee
Human-written only.
24/7 Support
Anytime, anywhere.
Plagiarism Free
100% Original.
Expert Tutors
Masters & PhDs.
100% Confidential
Your privacy matters.
On-Time Delivery
Never miss a deadline.
Your task is to find the cost of capital (WACC) for a company
Your task is to find the cost of capital (WACC) for a company. The company has three sources of capital available. The marginal tax rate for the company is 20%.
Debt: 5000 discount bonds with $500 par value, with 6 year to maturity. Bonds currently offer 4% yield to bondholders.
Preferred stock: 24 000 shares outstanding with $110 market price and 5% yield.
Common stock: 200 000 shares outstanding with the book value of $20 but currently trading at P/B=2.0. One may apply CAPM to estimate the cost of equity. Inputs for estimations are: risk free rate 2.0%, expected market return (Rm) 10.0% and the stock beta is 1.5.
Find the cost of each financing source, capital structure weights for each source and finally WACC.
Expert Solution
Calculation of cost of financing of each source:
Cost of debt = Coupon rate * (1-tax rate) = 4% * (1-20%) = 4% * 80% = 3.2%
Cost of preference share = Yield rate = 5%
Cost of equity = Rf + [B * (Rm - Rf)] = 2% + [1.5 * (10% - 2%)] = 2% + [1.5 * 8%] = 2% + 12% = 14%
Calculation of capital structure weight of each source:
Exsiting structure:
Debt = 5000 bond * $500 = $2,500,000
Preference shares = 24,000 shares * $110 = $2,640,000
Equity shares = 200,000 shares * $20 * 2 = $8,000,000
Total Capital = $2,500,000 + $2,640,000 + $8,000,000 = $13,140,000
weight:
Debt = $2,500,000 / $13,140,000 = 19.03%
Preference shares = $2,640,000 / $13,140,000 = 20.09%
Equity shares = $8,000,000 / $13,140,000 = 60.88%
Calculation of WACC:
WACC = [(cost of debt * weight of debt) + (cost of preference share * weight of preference share) + (cost of equity share * weight of equity share)]
WACC = [(3.2% * 19.03%) + (5% * 20.09%) + (14% * 60.88%)]
WACC = [0.61% + 1% + 8.52%]
WACC = 10.13%
Archived Solution
You have full access to this solution. To save a copy with all formatting and attachments, use the button below.
For ready-to-submit work, please order a fresh solution below.
