Question

Hey guys can you please help me solve this problem.
Calculate the Weighted Average Cost of Capital (WACC) for a company with the following capital structure (20 points)?

- 15,000,000 shares of common stock outstanding at current market price of $2.75/share
- 2,000,000 shares of preferred stock with par value of $10.00/share and paying an annual dividend of 8.5%
- Long-term debt of $45,000,000 with an interest rate of 7%

The combined federal and state tax rate is 38% and you can assume that equity investors in the company are looking to achieve the long-term stock market return of 12.5%

Answer 1

this is to the best of my knoeledge.. i have tried to answer.. see the atttached file... correct me if i am wrong

Answer 2

The problem that i have is that I dont know how to find Rd and Re
in the problem this is where i am stuck once I have this I am good to go

Answer 3

10*2`000`000 is par value of pref. stocks, not market value.

So I think you should calculate market value of pref. stocks as (10*0.085/0.125)*2`000`000.

It would change weights, that Sevak Manukyan calculated, to common stocks = 41.31%; preferred stocks = 13.62%; debt = 45.07%, and WACC would be 8.28%, that is pretty close.

Answer 4

what is Rd and Re

Answer 5

I'm not exactly sure of this but perhaps in the simplest format:
total value of the firm = 15M*2.75 + 2M*10 + 45M
WACC = 12.5%*15M/(15M*2.75 + 2M*10 + 45M)+8.5%*2M/(15M*2.75 + 2M*10 + 45M) + 7%*45M/(15M*2.75 + 2M*10 + 45M)
There are 3 different components, with respect to the common shares, preferred shares and debt components. It's just a weighted average cost of each category of capital.

Hope this helps.

Answer 6

Michael is almost right... Just remember to multiply the cost of debt (7%) by (1-tax rate)

Answer 7

Ah right. Thank you Prof.