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# Weighted Average Cost of Capital (WACC) explained in this solution

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ABC Co. is estimating its WACC. Its target capital is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semi-annully, a current maturity of 20 years, and sell for \$1,000. The company could sell, at par, \$100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. ABC Company's beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. ABC Co. is a constant-growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find common stock (rs). The firm's marginal tax rate is 40 percent.

What is ABC Co. component cost of debt?
Cost of preferred stock?
Cost of common stock (rs) using the CAPM approach?
Cost of common stock (rs) using the DCF approach?
Cost of common stock using the bond-yield-plus-risk-premium approach?
What is ABC Co. WACC?

#### Solution Preview

ABC Co. is estimating its WACC. Its target capital is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannully, a current maturity of 20 years, and sell for \$1,000. The company could sell, at par, \$100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. ABC Company's beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. ABC Co. is a constant-growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find common stock (rs). The firm's marginal tax rate is 40 percent.
What is ABC Co. component cost of debt?
Cost of preferred stock?

Cost of common stock (rs) using the CAPM ...

#### Solution Summary

Calculates cost of debt, cost of preferred stock, cost of common stock using the CAPM approach, cost of common stock using the DCF approach, cost of common stock using the bond-yield-plus-risk-premium approach and WACC

\$2.19
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