The Johnny Joe McGovern Company has the following capital structure that it cons

Question

The Johnny Joe McGovern Company has the following capital structure that it considers optimal:

                        DEBT                                      30%
                        PREFERRED STOCK            10%
                        COMMON STOCK                  60%

The firm plans to spend $100,000,000 on new capital projects. New bonds can be sold at par with an 8% coupon rate. Preferred stock can be sold with a dividend of $2.75, a par value of $25.00, and a floatation cost of $2.00 per share. Common stock is presently selling at $35.00 per share. The last dividend paid was $3.00 and the firm expects to grow at a rate of 4% in the foreseeable future. The firm's marginal tax rate is 40%. Calculate the firm’s weighted average cost of capital.

Explanation / Answer

A firms weighted average cost of capital is calculated by considering the target weights of capital structure. If target weight is missing, then we use market weights.

In this case, target weight is given so we will use that and ignore market weights

Cost of debt = 8% ( 1 - 40%) = 4.8%

Cost of preferred stock = (2.75 + 2) / 25 = 19%

Cost of common stock can be calculated by Gordon growth model as Dividend One year hence / Current stock price + growth rate = 3.00(1 + 4%) /35 + 4% = 12.91%

WACC = 30% * 4.8% + 10% *19% + 60% * 12.91% = 11.09%

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.