(Cost of Capital) You are provided the following information on a company. The t
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Question
(Cost of Capital)
You are provided the following information on a company. The total market value is $38 million. The company%u2019s capital structure, shown here, is considered to be optimal.
Market Value
Bonds, $1000 par, 6% coupon, 5% YTM $10,000,000
Preferred Stock, 4%, $100 par, 100,000 shares @ $60 per share $6,000,000
Common Stock, 100,000 shares @ $220 per share $22,000,000
a. What is the after-tax cost of debt? (assume the company%u2019s effective tax rate = 40%)
b. Assuming a $4 dividend paid annually, what is the required return for preferred shareholders (i.e. component cost of preferred stock)? (assume floatation costs = $0.00)
c. Assuming the risk-free rate is 1%, the expected return on the stock market is 7%, and the company's beta is 1.0, what is the required return for common stockholders (i.e., component cost of common stock)?
d. What is the company's weighted average cost of capital (WACC)?
Explanation / Answer
a) .05 * (1-.4)= .03
b) 4/60 .0667
c) .01+ 1.0(.07-.01)= = .07
d) 10/38 * .03 + 6/38 *.0667 + 22/38 * .07= .0589 5.89% WACC
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