AZ Products has 375,000 shares of common stock outstanding at a market price of $35 a share. Next year's annual dividend is expected to be $1.50 a share and the dividend growth rate is 2 percent. The firm also has 7,500 bonds outstanding with a face value of $1,000 per bond. The bonds have a pretax yield of 7.65 percent and sell at 98.6 percent of face value. The company's tax rate is 34 percent. What is the firm's weighted average cost of capital?

The firm's weighted average cost of capital 5.81%

Explanation:

In order toTo calculate WACC, we need to calculate the cost of equity and after-tax cost of debt. The WACC can be calculated with the use of following formula:

WACC = After-Tax Cost of Debt*Weight of Debt + Cost of Equity*Weight of Equity

Where,

After-Tax Cost of Debt = Pretax Yield*(1-Tax Rate)

Market Value of Debt = Outstanding Bonds*Par Value*Current Selling Percentage

Cost of Equity = D1/Current Market Price + Growth Rate

Market Value of Equity = Number of Common Shares Outstanding*Current Market Price

Weight of Debt = Market Value of Debt/(Market Value of Debt + Market Value of Equity)

Weight of Equity = Market Value of Equity/(Market Value of Debt + Market Value of Equity)

Therefore, Market Value of Debt = 7,500*1,000*98.60% = $7,395,000

Market Value of Equity = 375,000*35 = $13,125,000

Weight of Debt = 7,395,000/(13,125,000 + 7,395,000)

Weight of Equity =$13,125,000 /($13,125,000  + 7,395,000)

Cost of Equity = 1.50/35 + 2% = 6.28%      0.01801

After-Tax Cost of Debt = 7.65*(1-34%) = 5.05%

Using the values calculated above in the formula for WACC, we get,

WACC = 5.05%*7,395,000/(13,125,000 + 7,395,000) + 6.28% *$13,125,000/($13,125,000 + 7,395,000) = 5.81%

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