ABC enterprises has the balance sheet items listed below:
Accounts payable 6,000
Bank debt (notes payable) 8,000
Long-term debt 7,000
Preferred stock 4,000
Common stock 8,000
Retained earnings 25,000
Total liabilities and net worth 62,000
The market values are equal to the book values and the company expects to maintain its current capital structure.
The company is paying 12 percent on borrowings from the bank and expects that rate to continue. The company can issue new long-term debt at 10.7 percent. Preferred stock has a required return of 11.5 percent. The stock is currently selling at $20 per share on an expected annual dividend growth of 6.4% with an expected dividend of $2 the next year. The tax rate is 46%.
What is ABC enterprises' weighted average cost of capital (WACC)?
The base amount of debt and equity is $8,000 + $7,000 + $4,000 + $8,000 + $25,000 = $52,000.
The weights ascribed to the various forms of financing are as follows:
Bank debt = $8,000/$52,000 = 0.154
This solution analyzes the weighted average cost of capital for a company with bank debt, long-term debt, preferred stock, and common equity.