PNB Industries has 20 million shares of common stock outstanding with a market price of $18.00 per share. The company also has outstanding preferred stock with a market value of $50 million, and 500,000 bonds outstanding, each with face value $1,000 and selling at 104 percent of par value. The cost of common stock is 15 percent, the cost of preferred stock is 12 percent, and the cost of debt is 8.50 percent. All costs are given at the before-tax level. If PNB's tax rate is 21 percent, what is the WACC?
A) 7.05 percent
B) 10.21 percent
C) 8.85 percent
D) 11.83 percent

Question

Quizplus · Accepted Answer

To calculate the Weighted Average Cost of Capital (WACC), we first determine the market values of equity (E), preferred stock (P), and debt (D), then calculate the weights of each, and finally apply the formula:$$ WACC = \frac{E}{V} \times Re + \frac{P}{V} \times Rp + \frac{D}{V} \times Rd \times (1 - Tc) $$Where:- $E$ is the market value of equity,- $P$ is the market value of preferred stock,- $D$ is the market value of debt,- $V$ is the total market value of the firm (E + P + D),- $Re$ is the cost of equity,- $Rp$ is the cost of preferred stock,- $Rd$ is the cost of debt,- $Tc$ is the corporate tax rate.Given:- $E = 20 \text{ million shares} \times \$18.00/\text{share} = \$360 \text{ million}$,- $P = \$50 \text{ million}$,- $D = 500,000 \text{ bonds} \times \$1,000 \times 104\% = \$520 \text{ million}$,- $Re = 15\%$,- $Rp = 12\%$,- $Rd = 8.5\%$,- $Tc = 21\%$.Total market value, $V = E + P + D = \$360 \text{ million} + \$50 \text{ million} + \$520 \text{ million} = \$930 \text{ million}$.Weights:- Weight of equity, $W_e = \frac{E}{V} = \frac{\$360 \text{ million}}{\$930 \text{ million}}$,- Weight of preferred stock, $W_p = \frac{P}{V} = \frac{\$50 \text{ million}}{\$930 \text{ million}}$,- Weight of debt, $W_d = \frac{D}{V} = \frac{\$520 \text{ million}}{\$930 \text{ million}}$.$$ WACC = W_e \times Re + W_p \times Rp + W_d \times Rd \times (1 - Tc) $$$$ WACC = \frac{\$360 \text{ million}}{\$930 \text{ million}} \times 15\% + \frac{\$50 \text{ million}}{\$930 \text{ million}} \times 12\% + \frac{\$520 \text{ million}}{\$930 \text{ million}} \times 8.5\% \times (1 - 21\%) $$Calculating the above gives a WACC of approximately 10.21 percent.

PNB Industries Has 20 Million Shares of Common Stock Outstanding