Novis Corporation has a cost of debt of 7%, a cost of equity of 11%, and a cost

Question

Novis Corporation has a cost of debt of 7%, a cost of equity of 11%, and a cost of preferred stock
of 8%. The firm has 104,000 shares of common stock outstanding at a market price of $20 a share.
There are 40,000 shares of preferred stock outstanding at a market price of $34 a share. The bond
issue has a total face value of $500,000 and sells at 102% of face value. The tax rate is 34%. What
is the weighted average cost of capital for Novis Corporation?

Please give me the answer and how to solve this.

Explanation / Answer

Solution - Weighted average cost of capital AKA WACC is the average rate of return a company expects to compensate all its different investors. here the Weightage is considered for Debt and equity as per the share of them in the Total of Debt and equity financing. Formula is as below

WACC = [E/V x Re] + [(D/V x Rd) x (1-T)]

Where

E = Market value of the equity

D = Market value of the debt

V = Total Market Value (E + D)

Re = Cost of Equity

Rd= Cost of Debt

T= Tax Rate

Now in this question problem we have cost of equity & cost of preferred stock separately and even the market price are separete so we have to consider the Equity in two proportions.

Cost of Debt is available with us.

We need to find out the Market value for all the three components and then theie weightage amoung them

now we add two components of cost of Equity in the formula ( one for equity ie common stock and one for preferred stock )

WACC = [E1/V x Re1] + [E2/V x Re2] + [(D/V x Rd) x (1-T)]

WACC = [2080000/3950000 x 11%] + [1360000/3950000 x 8%] + [(510000/3950000 x 7%) x (1-34%)]

WACC =0.0579 + 0.0275 + 0.00596

WACC =0.09136 or 9.14%

1 Common stock shares outstanding 104000 2 Market price per Share 20 E1 Market Value of Common Stock ( 1 x 2) 2080000 3 Preferred stock shares outstanding 40000 4 Market price per Share 34 E2 Market Value of Preferred Stock ( 3 x 4) 1360000 5 Face value of Bonds Issued 500000 6 Selling Price of Bonds Issued compare to face balue 102% D Market Value of Debt ( 5 x 6) 510000 V Total Market Value (E1+E2+D) 3950000

Related Questions

Navigate

• Browse (All)
• Browse N
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.