P 0 $50.00 Net P pf $30.00 D pf $3.30 D 0 $2.10 g 7% B-T r d 10% Skye\'s beta 0.
ID: 2644132 • Letter: P
Question
P0
$50.00
Net Ppf
$30.00
Dpf
$3.30
D0
$2.10
g
7%
B-T rd
10%
Skye's beta
0.83
Market risk premium, MRP
6.0%
Risk free rate, rRF
6.5%
Target capital structure from debt
45%
Target capital structure from preferred stock
5%
Target capital structure from common stock
50%
Tax rate
35%
Flotation cost for new common stock
10%
Compute cost of debt.
Compute cost of preferred stock
Compute cost of common equity from retained earnings , using CAPM.
Using the target capital structure, find the company's WACC.
P0
$50.00
Net Ppf
$30.00
Dpf
$3.30
D0
$2.10
g
7%
B-T rd
10%
Skye's beta
0.83
Market risk premium, MRP
6.0%
Risk free rate, rRF
6.5%
Target capital structure from debt
45%
Target capital structure from preferred stock
5%
Target capital structure from common stock
50%
Tax rate
35%
Flotation cost for new common stock
10%
Explanation / Answer
(a) Computation of cost of Debt.We have,
Cost of Debt(Kd ) = Interest ( 100 - tax rate) / Market value of debt
Cost of Debt(Kd ) = 2.10 (100 - 35) / 30
Cost of Debt(Kd ) = 4.55%
Hence, Cost of Debt(Kd ) is 4.55%.
(b) Computation of cost of Preferred stock.We have,
Cost of preffered Stock(Kp ) = Dividend / Net proceed
Cost of preffered Stock(Kp ) = 3.30 / ( 50 - (50 x 10%))
Cost of preffered Stock(Kp )= 3.30 / 45 = 7.33 %
Hence, Cost of preffered Stock(Kp ) is 7.33%.
(c) Cost of common equity from reatined earnings, using CAPM.We have,
Ke = Rf+ Beta( Rm - Rf)
Where,
Ke = Cost of Equity
Rm = Return on market
Rf = Risk-free rate of return
Ke = 6.5 + 0.83 x 6.0
Ke = 10.98 %
Hence, Cost of equity is 10.98%.
(d) Computation of Company's WACC.We have,
WACC = 10.98 X 50/100 + 4.55 X 45/100 + 7.33 X 5 /100
WACC = 5.49 + 2.05 + 0.37
WACC = 7.91%
Hence, Company WACC is 7.91%.
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