Question

The capital structure of Global Motors is as follows: 55% common stock; 10% preferred stock; and 35% long term debt. The expected risk premium of Global Motor’s stock vs. US long-term Govt bonds is 7.5%. The 20-year US long-term Govt. default-free bond yield is 6.0%. The company’s credit rating is A- and the credit spread for 20-year A- corporate debt is 1.0%. Global Motor’s tax rate is 30%. The company recently issued preferred stock with a par value = $60/share that pays a 12% dividend yield. Issuance costs were 2.5% of pa

Answer 1

The question involves calculating the weighted average cost of capital for Global Motors, using the given capital structure percentages, risk premium, bond yields, credit spread, tax rate, and preferred stock details.

Step-by-step explanation:

The capital structure of Global Motors consists of 55% common stock, 10% preferred stock, and 35% long term debt. The expected risk premium of Global Motor’s stock as compared to US long-term government bonds is 7.5%. Additionally, the 20-year US long-term government default-free bond yield is 6.0%, and Global Motor’s A- credit rating implies a credit spread for 20-year A- corporate debt of 1.0%. Taking into account Global Motor’s tax rate of 30%, we can calculate the cost of debt after taxes by adjusting the government bond yield with the credit spread and then factoring in the tax savings due to interest being tax-deductible.

For the preferred stock, the cost of preferred stock can be calculated using the dividend yield on the issued preferred stock, which is 12% based on the par value of $60/share, albeit adjusting for issuance costs of 2.5% of par. These figures are crucial in determining the company's weighted average cost of capital (WACC).