(Show all your work 6 points each ) 4. The balance sheet for Stratton Co. shows
ID: 2750659 • Letter: #
Question
(Show all your work 6 points each)
4. The balance sheet for Stratton Co. shows $400,000 in common equity, $100,000 in preferred stock, and $500,000 in long-term debt. The company has 20,000 common shares outstanding at a market price of $65 per share. The firm’s 4,000 shares of preferred stock are currently priced at $50 per share. The firm has 500 bonds outstanding selling at par value ($1,000). The company’s before-tax cost of debt is 6%. The cost of common stock and preferred stock are estimated to be 10% and 7% respectively. If the firm’s marginal tax rate is 40%, what is the firm’s weighted average cost of capital (WACC)?
Explanation / Answer
Market value weights = Market value of individual /total market value cost weight *cost After tax cost of debt 500*1000= 500,000 500,000 / 2,000,000 = .25 6(1-.40) = 6*.6 = 3.6 .9 preferred stock 4000*50 = 200000 .10 7 .7 common stock 20,000 * 65 = 1300000 .65 10 6.5 Total market value 2000000 WACC 8.10%
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