Question

Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 7.5%. The company also has 750,000 shares of 7% preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $65 a share. The common stock has a beta of 1.34 and sells for $42 a share. The cost of equity is 14.06%. The corporate tax rate is 38%.

What is the firm's weighted average cost of capital?
a. 10.15%
b. 10.64%
c. 11.18%
d. 1.30%

Answer 1

A) 10.15%

Step-by-step explanation:

Cost of equity (Re) = 14.06% or 0.1406

cost of preferred stock (Rp) = 7/65 = 0.10769

cost of bonds (Rb) = 7.5% or 0.075

outstanding shares = 2.5 million shares x $42 = $105 million

bonds outstanding = $1,000 x 80,000 bonds = $80 million

preferred stock = $65 x 750,000 = $48.75 million

corporate tax rate = 38% or 0.38

total market value of equity + debt (in millions) = $105 + $48.75 + $80 = $233.75

WACC = [(outstanding shares / total market value) x Re] + [(preferred stock / total market value) x Rp] + {[(bonds outstanding / total market value) x Rb] x (1 - tax rate)}

WACC = [($105m / $233.75m) x 0.1406] + [($48.75m / $233.75m) x 0.10769] + {[($80m / $233.75m) x 0.075] x (1 - 0.38)}

WACC = 0.06316 + 0.02246 + 0.01591 = 0.10153 or 10.15%