Question

The Brownstone Corporation has 6 million shares of common stock outstanding, 600,000 shares of preferred stock that pays an annual dividend of $8, and 200,000 $1,000 par value bonds with a 10% coupon (semi-annual interest) and 20 years to maturity. At present, the common stock is selling for $50 per share, the bonds are selling for $950.62 per $1,000 of face value, and the preferred stock is selling at $74 per share. The estimated return on the market is 13%, the risk free rate is 8%, and Brownstone’s beta is 1.4. Assuming a tax rate is 30%, find the weighted average cost of capital. I know the answer is 11.96%, I am looking for the steps on how to find the answer.

Answer 1

The formula to calculate WACC is given below: (Common equityxr. \+ Preferred equity xr, Debt xľ, x(1-T) Value WACC = Value Value Here, The pretax cost of debt is denoted as r,. The cost of common equity and preferred equity are denoted as r, and r, respectively. The sum of debt, common equity, and preferred stock is denoted as Value. Essentially this formula calculated the weighted average of the costs of all sources of finance, hence the name WACC. Calculation of cost of equity and the total market value of equity: Calculate the market value of equity as follows: Market value of equity = Share pricex Number of shares outstanding = $50x 6,000,000 =$300,000,000 Calculate the cost of equity using CAPM as follows: Cost of equity =risk-free rate + Beta x (Market return – risk-free rate) = 8%+1.4x(13%-8%) = 8%+ 7% = 15% Calculation of cost of preferred equity and the total market value of preferred equity: Calculate the market value of preferred equity as follows: Market value of preferred equity = Share pricex Number of shares outstanding = $74x 600,000 =$44,400,000 Calculate the cost of preferred equity as follows: Preferred dividend Cost of preferred equity = Share price $8 $74 =10.810811% Calculation of market value of debt and the after-tax cost of debt: Calculate the market value of debt as follows: Market value of preferred equity =Bond pricex Number of bonds outstanding = $950.62 x 200,000 =$190,124,000 Calculate the after-tax cost of debt in excel as follows:

A 1 Item Value Formulas used 2 Face value $1,000 3 Coupon rate (semiannual) 4 Seminannual coupons 5 Years till maturity 6 Selling price 7 Pretax cost of debt 8 Tax rate 9 Post tax cost of debt 10% =B3/2*B2 $50 20 $950.62 10.5994% =2*RATE(B5*2,B4,-B6,B2) 30% =B7*(1-B8) 7.4196% 10 Now, calculate the market weights for each of the sources of finance, multiply those weights by their respective costs. The sum of those respective weighted costs is the WACC. Calculations are shown below: A в Market weight = Market value/Total Weighted cost = Market Market value Item Cost market value weight"Cost $ 190,124,000 Debt 0.355688426 7.42% 2.64% 2 3 Preferred equity $ 44,400,000 10.81% 0.90% 0.083064558 4 Common equity $ 8.42% 15% 300,000,000 0.561247016 $ 534,524,000 Total 11.96% 5 WACC Therefore, the WACC in this case is 11.96%