Calculate the weighted average cost of capital in the given case.
Based on the information below, calculate the weighted average cost of capital.
Great Corporation has the following capital situation.
Debt: One thousand bonds were issued five years ago at a coupon rate of 8%. They had 25-year terms and $1,000 face values. They are now selling to yield 9%. The tax rate is 39%
Preferred stock: Two thousand shares of preferred are outstanding, each of which pays an annual dividend of $7.50. They originally sold to yield 15% of their $50 face value. They're now selling to yield 8%.
Equity: Great Corp has 133,000 shares of common stock outstanding, currently selling at $12.48 per share. Dividend expected for next year is $.80 and the growth rate is 6%.
Let us calculate current value of bond.
Tax Rate=T=39%
Required rate of return=rd=9%
Coupon payment=C=1000*8%=$80
Number of coupon payments left=n=20
Maturity amount of bond=M=Face Value=$1000
Fair price of a bond is given as
Current price of bond=C/r*(1-1/(1+r)^n)+M/(1+r)^n
=80/9%*(1-1/(1+9%)^20)+1000/(1+9%)^20
=$908.71454
Current Market value of debt=Md=908.71454*1000=$908,714.54
Let us now calculate Market Value of preferred stock.
Constant Dividend of preferred stock=Dp=$7.50
Current Yield of preferred stock=rp=8%
Current Price of stock=D/rp=7.50/8%=$93.75
Current Market Value of preferred stock=Mp=93.75*2000=$187,500
Current market value of common stock=Mc=12.48*133000=$1,659,840
Now we calculate the cost of equity
D1=$0.80
Growth rate=g=6%
Rate of return on common stock=rc=(D1/Po)+g=(0.80/12.48)+6%=12.41%
Total Market Value of firm=M=Md+Mp+Mc=908714.5+187500+1659840=$2,756,055
Weighted average cost of capital,WACC is given by
WACC=(Md/M)*rd*(1-T)+(Mp/M)*rp+(Mc/M)*rc
=(908714.5/2756055.54)*9%*(1-39%)+(187500/2756055.54)*8%+(1659840/2756055.54)*12.41%
=9.83%