Question

Problem 1: Making use of the Capital Asset Pricing Model, compute the cost of Common Equity assuming a risk-free rate of 3.0%, a market rate of 4% and an assumed Beta of 1.1. Assume the following Capital Structure Weighted Average Cost of Capital Data Capital Structure Debt 0.3 Preferred Stock 0.2 Common Equity 0.5 Information Bond Yield to Maturity (YTM) 0.06 Corp Tax Rate 0.3 Dividends (preferred stock) 1.55 Price (preferred stock) 25 Floatation Cost 1 Dividends (common stock) 1 Price (common stock) 15 Growth Rate Common Stock 0.02 Find: (from A2.4 Problems) Cost of Debt (from A2.4 Problems) Cost of Preferred (from A2.5 Problems) Cost of Common Weighted Average Cost *Assuming this is Outstanding Common Stock Calculate Cost of Debt ? Cost of Preferred? Cost of Common ? Weighted Average Cost?

Answer 1

Answer:

Common Equity:
Cost of Equity = Risk Free Rate + Beta * (Market Return – Risk Free Rate)
Cost of Equity = 3.0% + 1.1 * (4.0% - 3.0%)
Cost of Equity = 4.1%

Debt:
Yield to maturity = 0.06
After Tax Cost of Debt = 0.06 * (1 – 0.30)
After Tax Cost of Debt = 0.042 or 4.2%

Preferred Stock:
Cost of Preferred Stock = Annual Dividend / Current Price * 100
Cost of Preferred Stock = $1.55 / ($25.00 - $1.00) * 100
Cost of Preferred Stock = 6.458%

WACC = (Weight of Equity * Cost of Equity) + (Weight of Debt * After Tax Cost of Debt) + (Weight of Preferred Stock * Cost of Preferred Stock)
WACC = (0.50 * 0.0410) + (0.30 * 0.0420) + (0.20 * 0.06458)
WACC = 0.0460 or 4.60%