Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds w
ID: 2659810 • Letter: P
Question
Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital?
The answer my professor gives is 10.15% but I keep getting 9.37%
Explanation / Answer
Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital?
Market Value of Capital Structure
Market Value of Bond = 80000*1000 = 80,000,000
Market Value of Pref Stock = 750000*65 = 48,750,000
Market Value of Common Stock = 2500000*42 = 105,000,000
Market Value of Total Capital Structure = 233,750,000
Weights
Weights of Bond = 80,000,000/233,750,000
Weights of Pref Stock = 48,750,000/233,750,000
Weights of Common Stock = 105,000,000/233,750,000
Cost of Pref Stock = 7%
Cost of Equity = 2.8 + (11.20-2.80)*1.34 = 14.056%
Cost of after tax debt =7.50 *0.62 = 4.65%
WACC = Cost of after tax debt*Weights of Bond + Cost of Pref Stock*Weights of Pref Stock + Cost of Equity*Weights of Common Stock
WACC = 4.65*80,000,000/233,750,000 + 7* 48,750,000/233,750,000 + 14.056*105,000,000/233,750,000
WACC = 9.37%