Question

Phillips Equipment has 75,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 7.5%. The company also has 750,000 shares of 6% preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $64 a share. The common stock has a beta of 1.21 and sells for $44 a share. The U.S. Treasury bill is yielding 2.3% and the return on the market is 11.2%. The corporate tax rate is 34%. What is the firm's weighted average cost of capital?

Answer 1

Answer: 9.69%

Explanation:

Cost of debt = Yield * ( 1 - Tax)

= 7.5% * (1 - 34%)

= 4.95%

Cost of Preferred stock = Dividend/ Price

= 6/64

= 9.38%

Cost of Equity = risk free rate + beta * (market return - risk free rate)

= 2.3% + 1.21 * (11.2% - 2.3%)

= 13.07%

Total values of capital;

Debt = 75,000 * 1,000 par value = $75,000,000

Preferred stock = 750,000 * 64 = $48,000,000

Common stock = 2,500,000 * 44 = $110,000,000

Total = 75,000,000 + 48,000,000 + 110,000,000

= $233,000,000

WACC = (75,000,000/ 233,000,000 * 4.95%) + (48,000,000/233,000,000 * 9.38%) + (110,000,000/233,000,000 * 13.07%)

= 1.59% + 1.93% + 6.17%

= 9.69%