Given the following information, calculate the weighted average cost for the Ban

Question

Given the following information, calculate the weighted average cost for the Ban Corp.
Percent of capital structure:
Preferred stock                                                      10%
Common equity                                                     70%
Debt                                                                      20%

Additional information:
Corporate tax rate                                                  34%
Dividend, preferred                                                $8.00
Dividend, expected common                                  $4.00
Price, preferred                                                      $80.00
Growth rate                                                            5%
Bond yield                                                             7%
Price, common                                                         $80.00 (Points : 40)            

Explanation / Answer

Answer:

Weighted Average Cost of Capital (WACC) = (E / V) x Re + (P / V) x Rp + (D / V) x Rd (1 - Tc)

here,

Re = cost of common stock

Rp = cost of preferred stock

Rd = cost of debt

E = market value of the firm's equity

E = market value of the firm's common stock

P = market value of the firm's preferred stock

D = market value of the firm's debt

V = E + P + D = total market value of the firm’s financing (Common Stock + Preferred Stock + Debt)

E/V = percentage of financing that is common stock

P/V = percentage of financing that is preferred stock

D/V = percentage of financing that is debt

Tc = corporate tax rate

therefore, in the given question;

WACC = [70% x {( Expected Common Dividend / Market Value of Common Stock) + Growth Rate}] + {10% x ( Expected Preferred Dividend / Market Value of Preferred Stock)} + {20% x Bond Yield x (1 - Corporate Tax Rate)}

WACC = [70% x {( $ 4.00 / $ 80.00) + 5%}] + {10% x ( $ 8.00 / $ 80.00)} + {20% x 7% x (1 - 34%)}

WACC = 70% x 10% + 10% x 10% + 20% x 4.62% = 7% + 1% + 0.942% = 8.942%

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