Question

FarCry Industries, a maker of telecommunications equipment, has 26 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares sell for $15 per share, the preferred shares sell for $114.50 per share, and the bonds sell for 101 percent of par ($1,000), what weight should you use for preferred stock in the computation of FarCry's WACC

Answer 1

Answer:

wP = 114.5 / 514.6   = 0.2225 or 22.25%

Explanation:

The WACC or weighted average cost of capital is the cost of a firm's capital structure. The capital structure of a firm can be made up of one or more of the following components namely debt, preferred stock and common equity. The WACC is normally calculated using the market value of these components. The formula for WACC is,

WACC = wD * rD * (1-tax rate)  +  wP * rP  +  wE * rE

Where,

• wD, wP and wE represents the weight of debt, preferred stock and common equity in the capital structure based on the market value
• rD, rP and rE are the cost of debt, preferred stock and common equity respectively.

To calculate the weight that should be assigned to the preferred stock in the calculation of WACC, we need to determine the market value of preferred stock and the market value of the capital structure.

Market Value - Debt = 10000 * 1000 * 1.01  =  $10.1 million

Market Value - Preferred stock = 1 * 114.50  = $114.5 million

Market Value - Common equity = 26 * 15  =  $390 million

Total MV of capital structure = 10.1 + 114.5 + 390  = $514.6

wP = 114.5 / 514.6   = 0.2225 or 22.25%