The Floyd Company has employed you to determine its weighted average cost of cap

Question

The Floyd Company has employed you to determine its weighted average cost of capital. The net income is projected to be $504,545 during the coming year. The marginal tax rate is 40%.

Debt:

Floyd has 3,000 7 percent coupon bonds outstanding, with 20 years to maturity, and a quoted price of 105. The bonds pay the coupons on a semi-annual basis.

Preferred:

Floyd has 20,000 shares of preferred stock. The preferred dividend is 2.50 and the current price is $50 per share.

Common Equity:

Floyd has 50,000 shares of common stock selling for $35 per share. The firm’s beta is 1.5

Market: The expected return on the market is 14% and the risk free rate is 4 percent.

Determine the cost of capital.

Explanation / Answer

Determination of the WACC:

Cost of debt after tax, r(D) = 7* (1-T) = 7 *(1 - 0.40) = 4.2%
Cost of preference = 2.5/50*100 = 5%

Cost of equity r(E) = 4% + 1.5(14-4) = 19%
weight of equity, W(E) = 0.43
weight of debt, W(D) = 0.13

Weight of preference = 0.43
(data of risk free rate is superfluous in this case)
WACC = W(E)*r(E) + W(D)*r(D) (after tax rate) + W(P)*r(P)
=> = 0.43*19+0.43*5+0.13*4.2
=> = 10.93 %

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