A construction company has 20 year bonds outstanding. The bonds have an 8.5% annual coupon, a face value of $1,000, and they currently sell for $945. The company's stock has a beta equal to 1.20. The market risk premium (km - krf) equals 5%. The risk free rate is 6%. The company has outstanding preferred stock that pays a $2 annual dividend. The preferred stock sells for $25 a share. The company's tax rate is 40%. The company's capital structure consists of 40% long-term debt, 40% common stock, and 20% preferred stock.
1. What is the company's after-tax cost of debt?
2. What is the company's after-tax cost of preferred stock?
3. What is the company's after-tax cost of common equity?
4. What is the company's WACC?
The cost of capital can also be viewed as the minimum rate of return required keeping investors satisfied. Thus it is used to know the rate of return expected by the investors.
Cost of capital (WACC)=
(Cost of Equity x Proportion of equity from capital)+ (Cost of debt x Proportion of debt from capital)+ ...
This solution answers four WACC questions, addressing after-tax costs of debt, preferred stock and common equity.