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5 votes
The Finance Manager, in implementing the strategic

management of the company, is required to determine
Dewpoint Inc.'s actual Weighted Average Cost of Capital
(WACC).
Debt: The company has $5,000 face value bonds that
currently sell for 105% of face value. The bonds carry an
8% coupon, pay interest annually, and mature in 10 years.
Common Stock: 3,000 shares outstanding with a market
price per share of $15.00. The company intends to pay a
dividend of $1.50 next year; dividends are expected to
grow by 2% annually.
Preference Shares: 200 shares of preferred stock at a
price of $10 per share and an annual dividend of $2 per
share.
Additional Information: The Company's Tax rate is 30%.
Required: Calculate the Weighted Average Cost of
Capital for Dewpoint Inc.

1 Answer

5 votes

Step-by-step explanation:

Calculate the cost of debt.

The cost of debt is the yield to maturity (YTM) on the company's bonds.

In this case, the YTM is 8%.

However, the company's tax rate is 30%, so the after-tax cost of debt is 8% * (1 - 0.30) = 5.6%.

Calculate the cost of equity.

The cost of equity is the expected return that investors require for holding the company's stock.

One way to estimate the cost of equity is to use the dividend discount model (DDM).

In the DDM, the cost of equity is equal to the dividend yield plus the growth rate of dividends.

In this case, the dividend yield is $1.50 / $15.00 = 10%.

The growth rate of dividends is expected to be 2%.

Therefore, the cost of equity is 10% + 2% = 12%.

Calculate the cost of preferred stock.

The cost of preferred stock is the dividend yield on preferred stock.

In this case, the dividend yield is $2 / $10 = 20%.

Weight the costs of debt, equity, and preferred stock according to their market values.

The market value of debt is $5,000 * 1.05 = $5,250.

The market value of common stock is 3,000 * $15 = $45,000.

The market value of preferred stock is 200 * $10 = $2,000.

Therefore, the weights for debt, equity, and preferred stock are 0.12, 0.84, and 0.04, respectively.

Calculate the WACC.

The WACC is the weighted average of the costs of debt, equity, and preferred stock.

In this case, the WACC is 0.12 * 5.6% + 0.84 * 12% + 0.04 * 20% = 9.76%.

Therefore, the weighted average cost of capital for Dewpoint Inc. is 9.76%.

Here is the formula for calculating WACC:

WACC = Σ(Weighti * Cost of Capitali)

where:

Σ is the sum of

Weighti is the weight of the ith source of capital

Cost of Capitali is the cost of the ith source of capital

User John Vasileff
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