As a member of the Finance Dept. of Ranch Manufacturing, your supervisor has ask

Question

As a member of the Finance Dept. of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm's present capital structure reflects the appropriate mix of capital sources fro the firm, you have determined the market value of the firm's capital structure as follows: Source of Capital Market Values Bonds $4,100,000 Preferred stock $1,600,000 Common stock $6,200,000 To finance the purchase, Ranch Manufacturing will sell 10 year bonds paying 6.6% per year at the mart price of $1066. Preferred stock paying a $1.92 dividend can be sold for $25.41. Common stock for Ranch Manufacturing is currently a rate of 4.9% per year into the indefinite future. If the firm's tax rate is 30%, what discount rate should you use to evaluate the equipment purchase? Ranch Manufacturing's WACC is ?% round to three decimals Please show how to calculate, thanks

Explanation / Answer

Need to find Yield to maturity on bonds. Put in a financial calculator you get 5.715% After tax is 5.715 (1-.3)= 4.00% Preferred is 1.92/25.41= 7.556% Common is ??? (need more data such as current dividend, dividend growth rate, and stock price). Take weighted average 4,100,000/(4,100,000+1,600,000+6,200,000) *4.00 = 1.378 1,600,000/(4,100,000 +1,600,000+ 6,200,000) *7.556= 1.0159 6,200,000/(4,100,000 +1,600,000+6,200,000) *Equity cost of capital Add together to get WACC.

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