Question

The Pharoah Products Co. currently has debt with a market value of $200 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,418.61 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $18 per share. The preferred shares pay an annual dividend of $1.20. Pharoah also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 6 percent per year forever. If Pharoah is subject to a 40 percent marginal tax rate, then what is the firm's weighted average cost of capital? Excel Template (Note: This template includes the problem statement as it appears in your textbook. The problem assigned to you here may have different values. When using this template, copy the problem statement from this screen for easy reference to the values you've been given here, and be sure to update any values that may have been pre-entered in the template based on the textbook version of the problem.) Calculate the weights for debt, common equity, and preferred equity. (Round intermediate calculations and final answers to 4 decimal places, e.g. 1.2514.) Debt Preferred equity Common equity

Answer 1

Market Value of Debt =200 million
Market Value of Preferred Stock =Number of Shares*Share Price =2*18 =36
Market Value of Equity =Number of Shares*Share Price =14*20 =280
Total market Value =200+36+280 =516

Weight of Debt =200/516=0.3876 or 0.39
Weight of Preferred Stock =36/516=0.0698 or 0.07
Weight of Equity =280/516=0.5426 or 0.54

Par Value =1000
Coupon =9%*1000/2 =45
Price of bond =1418.61
Number of periods =2*15 =30
Cost of debt using excel formula=2*RATE(30,45,-1418.61,1000)*(1-Tax Rate) =5.00%*(1-40%) = 3.00%

Cost of Preferred Stock =Annual Dividend/Price =1.20/18=6.67%
Cost of equity =Dividend Next year/Price + Growth =2.20/20+6% =17%

WACC =Weight of Debt*Cost of Debt + Weight of Preferred Stock*Cost of Preferred Stock + Weight of Equity*Cost of Equity
=0.3876*3.00%+0.0698*6.67%+0.5426*17% =10.85%