Question

For a large corporation, the annual cost of running business is called the Weighted Average Cost of Capital (or "WACC"). It is the average - or, more precisely, the weighted average of three things: cost of equity, cost of preferred stock, and cost of debt. Weighted Average Cost of Capital (a) Cost of preferred stock is nothing but the rate of return to investors buying common stock shares most recent dividend paid on each share of preferred stock 3 yield to maturity rate of return on preferred stock shares (b) Cost of debt - let's calculate it! A corporation issued 16-year bonds 3 years ago at a coupon rate of 6%. The bonds make semiannual payments. These bonds currently sell for 102% of par value. The corporation's cost of debt is 2.8895% 2 5.7770% 3 5.7791% 4 5.8064%

Answer 1

Answer a.

Cost of preferred stock is nothing but the rate of return on preferred stock shares.

Answer b.

Par Value = $1,000

Current Price = 102% * $1,000
Current Price = $1,020

Annual Coupon Rate = 6.00%
Semiannual Coupon Rate = 3.00%
Semiannual Coupon = 3.00% * $1,000
Semiannual Coupon = $30

Time to Maturity = 13 years
Semiannual Period = 26

Let Semiannual YTM be i%

$1,020 = $30 * PVIFA(i%, 26) + $1,000 * PVIF(i%, 26)

Using financial calculator:
N = 26
PV = -1020
PMT = 30
FV = 1000

I = 2.8895%

Semiannual YTM = 2.88954%
Annual YTM = 2 * 2.88954%
Annual YTM = 5.77908%

The corporation’s cost of debt is 5.7791%