Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds w
ID: 2708290 • Letter: P
Question
Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 7.5 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 $65 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?
Explanation / Answer
Cost of Common Stock = 2.8 + (11.20-2.80) * 1.34 = 14.056%
Cost of Preferred Stock = 7/65 = 10.769%
Cost of after tax debt = 7.50*0.62 = 4.65%
Maket Value:
Common stock = 2.5 Million * 42 = 105,000,000
Pref Stock = 750000*65 = 48,750,000
Debt = 80000*1000 = 80,000,000
Total Market Value = 233,750,000
Weight
Common stock = 105,000,000/233,750,000 = 105/233.75
Pref Stock = 48,750,000/233,750,000 = 48.75/233.75
Debt = 80,000,000/233,750,000 = 80/233.75
WACC = 14.056*105/233.75 + 10.769*48.75/233.75 + 4.65*80/233.75 =10.15%
Answer:
Firm's weighted average cost of capital = 10.15%