Lagoon Boat Sales has 300,000 shares of common stock outstanding at a market price of $44 a share. Last month, the company paid an annual dividend in the amount of $1 per share. The
Dividend growth rate is 3.5 percent. Lagoon also has 5,000 bonds outstanding with a face value of
$1,000 per bond. The bonds carry a 9.5 percent coupon, pay interest annually, and mature in 7.5
Years. The bonds are selling at 102 percent of face value. The company's tax rate is 34 percent.
What is Lagoon's weighted average cost of capital?

Question

Quizplus · Accepted Answer

The correct answer is A because the weighted average cost of capital (WACC) is 5.90 percent. The WACC is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)where:E = market value of equityV = total value of the firmRe = cost of equityD = market value of debtRd = cost of debtTc = corporate tax rateIn this case, the market value of equity is 300,000 shares * $44 per share = $13,200,000. The total value of the firm is $13,200,000 + $5,000,000 = $18,200,000. The cost of equity is calculated using the dividend growth model:Re = D1 / P0 + gwhere:D1 = next year's dividendP0 = current market price of the stockg = dividend growth rateIn this case, the next year's dividend is $1.035 per share ($1 per share * (1 + 3.5%)), the current market price of the stock is $44 per share, and the dividend growth rate is 3.5%. Therefore, the cost of equity is:Re = $1.035 / $44 + 3.5% = 6.00%The market value of debt is $5,000 bonds * $1,000 per bond * 1.02 = $5,100,000. The cost of debt is calculated as follows:Rd = C / Pwhere:C = annual coupon paymentP = market price of the bondIn this case, the annual coupon payment is $95 per bond ($1,000 per bond * 9.5%), and the market price of the bond is $1,020 per bond. Therefore, the cost of debt is:Rd = $95 / $1,020 = 9.31%The corporate tax rate is 34%. Therefore, the WACC is:WACC = (13,200,000 / 18,200,000) * 6.00% + (5,100,000 / 18,200,000) * 9.31% * (1 - 34%) = 5.90%

Lagoon Boat Sales Has 300,000 Shares of Common Stock Outstanding