1.) Brady Inc. has a targeted capital structure of 40% debt, 10% preferred stock
ID: 2789114 • Letter: 1
Question
1.) Brady Inc. has a targeted capital structure of 40% debt, 10% preferred stock, and 50% common stock. The marginal tax rate is 35%. Use the data below to calculate the company’s WACC. Ignore flotation costs.
-The S&P 500 is expected to be up 12% over the next year.
-Brady’s preferred stock that is being traded in the marketplace pays an annual dividend of $8.00.
-Brady’s common stock sells for $25.00 per share. The expected dividend on the common stock next year is $2.00 per share.
-Brady’s bonds sell at a discount. The ten year bonds are priced at 97% of par ($1000 par value).They are annual bonds with a 7% coupon rate.
-Brady’s preferred stock sells for $75 per share. Treasury bonds are priced to yield 4%.
-Management feels its investors expect a 6% growth rate for the stock. The beta of the stock is 1.2.
Explanation / Answer
Answer)
Weights of different sources of capital
Weight of debt = 0.40
Weight of equity = 0.50
Weight of preferred stock =0.10
Cost of debt =
N=10
PV =-97*1000
FV=1000
PMT = 7%*1000
Rate = calculated in excel = 7.436%
Before tax cost of debt = 7.436%
Cost of equity = Risk free rate + Beta * (Market Return - Risk free rate)
= 4% + 1.2*(12%-4%)
= 0.04 + 0.096
=0.136 or 13.6%
Cost of preferred share = preferred dividend / price of preferred share = 8/75 = 0.106667 or 10.667%
WACC =
Cost of equity * weight of equity + cost of debt * weight of debt *(1-tax rate) + cost of preferred share * cost of preferred share
WACC = 0.5 * 0.1360 + 0.4*0.07436*(1-0.35) +0.10*0.10667 = 0.098 OR 9.8%
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