ABC Corp. has 10 million shares of common stock outstanding. The common stock cu
ID: 2710743 • Letter: A
Question
ABC Corp. has 10 million shares of common stock outstanding. The common stock currently sells for $65 per share and has a beta of 0.75. The market risk premium is 8 percent and the risk-free rate is 3 percent.
The company has 2 million shares of preferred stock outstanding. The preferred stock currently sells for $80 per share and pays 4 percent dividend for each $100 face value.
The company also has 1 million semiannual bonds outstanding with a 6% coupon interest rate and par value $1,000 each. The bonds have 20 years to maturity and sell for 115 percent of the par. The company's average tax rate is 35 percent. Answer the following questions.
What is the weighted average cost of capital (WACC) of the company?
5.23%
6.22%
4.49%
5.48%
5.38%
5.23%
6.22%
4.49%
5.48%
5.38%
Explanation / Answer
Weighted average cost of capital is the average after tax cost of capital of the company, So to compute the weighted average cost of capital the cost of equity and cost of debt shall be computed separately. It shall be computed in following manner:
Cost of equity:
.03+0.75x(.08-.03)= 6.75%
The cost of debt shall be computed in folowing manner:
Cost of bonds:
.06 (1-0.35)
.06(.65)= 3.9%
Cost of preferred stock:
4/80= 5%
Computation of weights
=10 million+2 million + 1 million=1 3
For Equity = 10/13 = 0.77
For bonds =1/13 = 0.077
For perferred stock = 2/13=0.153
Computation of weighted average cost of capital:
0.77x0.0675+0.077x0.039 +0.153x.05
0.0519+0.03+.0076=6.23%
The answer is nearest to option B hence option B is the correct option