Question

Phillips Equipment has 6,500 bonds outstanding that are selling at 96.5 percent of par. Bonds with similar characteristics are yielding 6.7 percent, pretax. The company also has 48,000 shares of 5.5 percent preferred stock and 75,000 shares of common stock outstanding. The preferred stock sells for $64 a share. The common stock has a beta of 1.32 and sells for $41 a share. The preferred stock has a stated value of $100. The U.S. Treasury bill is yielding 2.2 percent and the return on the market is 10.6 percent. The corporate tax rate is 21 percent. What is the weighted average cost of capital?
9.30 percent

8.09 percent

10.18 percent

8.64 percent

Please show work, thank you!

Answer 1

Answer:

Ke = Rf  + β(Rm – Rf)

ke = 2.2 +  1.32 (10.6 - 2.2)

Ke = 2.2 + 1.32(8.4)

ke = 2.2 + 11.088

ke = 13.288%

kp = D/Po

kp = $5.50/$64

Kp = 0.0859375 = 8.59375%

Kd = 6.7%

Kd after tax = 6.7(1-0.21)  = 5.293

WACC = Ke(E/V) + kp(P/V) Kd(D/V)(1-T)

WACC = 13.288(3,075,000/12,419,500) + 8.59375(3,072,000/12,419500) + 5.293(6,272,500/12,419,500)

WACC = 3.29 + 2.126 + 2.6732

WACC  = 8.09%

The correct answer is B

Market value of the company:                                       $

Market value of equity                 = 75,000 x $41 = 3,075,000

Market value of preferred stock = 48,000 x  $64 = 3.072,000

Market value of debt                   = 6500    x  $96.5 = 6,272, 500

Market value of the company                                       12,419,500

The correct answer is B

Explanation:

In this question, we need to calculate cost of equity based on capital asset pricing model. Then, we will calculate cost of preferred stock as shown above.  Thereafter, the after-tax cost of debt will be computed as illustrated above. We also need to calculate the market value of the company. Finally, we will calculate weighted average cost of capital as computed above.