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.
Required rate of return=rd=9%
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
Solution depicts the steps to calculate the cost of individual components of capital. It also estimates the weighted average cost of capital(WACC) in the given case.
Calculating Weighted Average Cost of Capital (WACC)
If a company finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock.
1) The company can issue bonds at a yield to maturity of 8.4 percent.
2) The cost of preferred stock is 9 percent.
3) The company's common stock currently sells for $30 a share.
4) The company's dividend is currently $2.00 a share (D0 = $2.00), and is
expected to grow at a constant rate of 6 percent per year.
5) Assume that the flotation cost on debt and preferred stock is zero, and no
new stock will be issued.
The company's tax rate is 30 percent.
What is the company's weighted average cost of capital (WACC)?