Phillips Equipment has 75,000 bonds outstanding that are selling at par. Bonds w
ID: 2773656 • Letter: P
Question
Phillips Equipment has 75,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 7.5 percent. The company also has 750,000 shares of 6 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $64a share. The common stock has a beta of 1.21 and sells for $44 a share. The U.S. Treasury bill is yielding 2.3 percent and the return on the market is 11.2 percent. The corporate tax rate is 34 percent. What is the firm's weighted average cost of capital?
Explanation / Answer
Cost of debt Kd = YTM x (1-t)
= 7.5% x (1-0.34)
= 4.95%
Cost of preferred stock Kp = Annual dividend/ price
= 100 x6%/64
=9.375%
Cost of equity Ke = Rf +betax(Rm-Rf)
= 2.3% + 1.21 x(11.20%-2.3%)
= 13.069%
Weights:
Source
Price
Units
Price x units
Weight
Bond
1000
75000
75000000
0.3219
Preferred stock
64
750000
48000000
0.2060
Common stock
44
2500000
110000000
0.4721
233000000
WACC:
Source
Weights
Cost
Weight x cost
Bond
0.3219
4.950%
1.59%
Preferred stock
0.2060
9.375%
1.93%
Common stock
0.4721
13.069%
6.17%
9.69%
Hence, WACC is 9.69%
Source
Price
Units
Price x units
Weight
Bond
1000
75000
75000000
0.3219
Preferred stock
64
750000
48000000
0.2060
Common stock
44
2500000
110000000
0.4721
233000000