Question

(Topic: WACC) Here is some information about Stokenchurch Inc.:

Beta of common stock = 0.3
Treasury bill rate = 0.25%
Market risk premium = 4.37%
Yield to maturity on long-term debt = 1.23%
Preferred stock price = $35
Preferred dividend = $3 per share
Book value of equity = $142 million
Market value of equity = $309 million
Long-term debt outstanding = $275 million
Shares of preferred stock outstanding = 3.4 million
Corporate tax rate = 21%
What is the company's WACC?
(Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

The company's WACC is 1.07%.

Step-by-step explanation:

I calculate the cost of each type of financing as follows:

Cost of equity:

Re = Rf + beta * (Rm - Rf)

where Rf is the risk-free rate, Rm is the market return, and beta is the beta of the company's common stock.

Re = 0.0025 + 0.3 * 0.0437 = 0.01561 or 1.561%

Cost of debt:

Rd = YTM = 0.0123 or 1.23%

Cost of preferred stock:

Rp = Dp / Pp

where Dp is the preferred dividend and Pp is the preferred stock price.

Rp = 3/35 = 0.08571 or 8.571%

Next, we calculate the weights of each type of financing in the company's capital structure:

Weight of equity = market value of equity / (market value of equity + book value of debt + market value of preferred stock)

= $309 million / ($309 million + $275 million + $119 million)

= 0.4386

Weight of debt = book value of debt / (market value of equity + book value of debt + market value of preferred stock)

= $275 million / ($309 million + $275 million + $119 million)

= 0.3883

Weight of preferred stock = market value of preferred stock / (market value of equity + book value of debt + market value of preferred stock)

= $119 million / ($309 million + $275 million + $119 million)

= 0.1731

Finally, we can calculate the WACC as the weighted average of the cost of each type of financing:

WACC = (weight of equity * cost of equity) + (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) * (1 - corporate tax rate)

= (0.4386 * 0.01561) + (0.3883 * 0.0123) + (0.1731 * 0.08571) * (1 - 0.21)

= 0.0107 or 1.07%

Therefore, the company's WACC is 1.07%.