Question

Q4) Emca Enterprises has a target capital structure of 40% in debt, 50% in equity (common stock), and 10% in preferred stock. The YTM on Emca's bonds is 8.00%. Its preferred stock sells for $40 per share and pays a dividend of $4.50 per share. Its equity beta is 1.30. Assume the market risk premium is 7.5%, the risk-free rate is 2.5%, and the corporate tax rate is 25%. What is Emca Enterprises' WACC?

Please do by hand so I can see the steps.

A) 10.45%

B) 9.93%

C) 8.03%

D) 9.65%

E) 8.32%

Answer 1

Cost of preferred stock = Annual dividend/Current Price

Cost of preferred stock = $4.50/$40 = 11.25%

Cost of common stock can be calculated using CAPM equation, according to which

Cost of Equity = Risk free rate + Beta * Market risk premium

Cost of equity = 2.5% + 1.30 * 7.5%

Cost of Equity = 2.5% + 9.75% = 12.25%

WACC = 40% * 8% * (1 - 25%) + 50% * 12.25% + 10% * 11.25%

WACC = 9.65%