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 $14 per share and the common stock for $20 per share.

If the preferred stock pays a dividend of $4 per share, the beta of the common stock is 0.7, the market risk premium is 10%, the risk-free rate is 6%, and the firm%u2019s tax rate is 20%, 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 $ 1.0       Bonds, coupon = 8%, paid annually
    (maturity = 10 years, current yield to
     maturity = 9%) $ 5.0   Accounts receivable 4.0       Preferred stock (par value $20 per
     share) 3.0   Inventories 8.0       Common stock (par value $0.2) 0.2   Plant and equipment 20.0       Additional paid-in stockholders%u2019 equity 16.8    Retained earnings 8.0   Total $ 33.0       Total $ 33.0

Explanation / Answer

Solution: Security Market Value Debt $5.50 million Equity 15.00 million Total $20.50 WACC = 12.42%

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