The Basket Weavers Company has 100,000 bonds outstanding that are selling at par value. Their face value is $1,000 and they yield 7.5%. The company also has 1 million shares of preferred stock which pays 10.5% of dividends for 100$ of par. The preferred stocks sell for $56. The company has 5 million shares of common stocks whose current price is $38. This company’s beta is 1.2. The U. S. Treasury bill yields 3%. The return on the market is 12%. The corporate tax rate is 34%. Calculate WACC.

10.71%

Explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

According to WACC formula

WACC = ( Cost of equity x Weightage of equity ) + ( Cost of debt ( 1- t) x Weightage of debt ) + ( Cost of Preferred equity x Weightage of Preferred equity )

Cost of Equity

Capital asset pricing model measure the expected return on an asset or investment. it is considered as the cost of common stock.

Formula for CAPM

Cost of Equity = Risk free rate + beta ( market return - risk free rate )

Cost of Equity = Rf + β ( Rm - Rf )

Cost of Equity = 3% + 1.2 ( 12% - 3% ) = 13.8%

As we know, the yield on the bond is the actually cost of the bond liability.

Cost of Debt = 7.5%

Cost of Preferred Stock = 10.5%

Market Values

Common Stock = 5 million x $38 = $190 million

Preferred Stock = 1 million x $56 = $56 million

Debt = 100,000 x 1,000 = $100,000,000 = $100 million

Total Value = 190 + 56 + 100 = $346 million

WACC = ( 13.8% x 190/346 ) + ( 7.5% ( 1- 0.34) x 100/346 ) + ( 10.5% x 56/346 )

WACC = 7.58% + 1.43% + 1.70 = 10.71%

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