Examine the following book-value balance sheet for University Products, Inc. The

Question

Examine the following book-value balance sheet for University Products, Inc. The preferred stock currently sells for $10 per share and the common stock for $16 per share.

If the preferred stock pays a dividend of $2 per share, the beta of the common stock is 0.2, the market risk premium is 12%, the risk-free rate is 8%, and the firm%u2019s tax rate is 30%, what is University%u2019s weighted-average cost of capital? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

BOOK VALUE BALANCE SHEET
(all values in millions)
  Assets    Liabilities and Net Worth   Cash and short-term securities $ 2.0       Bonds, coupon = 6%, paid annually
    (maturity = 10 years, current yield to
     maturity = 7%) $ 10.0   Accounts receivable 5.0       Preferred stock (par value $10 per
     share) 1.0   Inventories 9.0       Common stock (par value $0.1) 0.2   Plant and equipment 22.0       Additional paid-in stockholders%u2019 equity 8.8    Retained earnings 18.0   Total $ 38.0       Total $ 38.0

Explanation / Answer

Cost of equity = 8 +0.2*4 = 8.8 %

10 = 2/r

r= 20 %

WACC = 8.8*27/38 + 7*10/38*0.7 + 1/38*20 = 8.068 %

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