As a newly hired financial analyst,your first job at VersaLife Corporation is to calculate the company's cost of capital.The present capital structure,which is considered optimal,is as follows:

If VersaLife Corporation issues new debt,then the bond market expects a yield of 7.5%.Preferred stock is trading for $96,has a $100 par value and pays an annual dividend of 8% (the next dividend is due in one year).Common equity has a beta of 1.20,the market risk premium is 5%,and the risk-free rate is 3%.If the firm's tax rate is 40%,what is the weighted average cost of capital? Round answers to the nearest tenth.

Question

As a newly hired financial analyst,your first job at VersaLife Corporation is to calculate the company's cost of capital.The present capital structure,which is considered optimal,is as follows:

If VersaLife Corporation issues new debt,then the bond market expects a yield of 7.5%.Preferred stock is trading for $96,has a $100 par value and pays an annual dividend of 8% (the next dividend is due in one year).Common equity has a beta of 1.20,the market risk premium is 5%,and the risk-free rate is 3%.If the firm's tax rate is 40%,what is the weighted average cost of capital? Round answers to the nearest tenth.

Quizplus · Accepted Answer

Step 1 - Calculate the capital structure weights. Debt = 80 / 200 = 0.40 Preferred Stock = 10 / 200 = 0.05 Common Stock = 110 / 200 = 0.55 Step 2 - Calculate the cost of each component of the capital structure. After-tax cost of debt = k_d(1 - T) 0.075(1 - 0.40) = 0.045 Cost of preferred stock: k_p = 11ea7fdb_fc73_470c_a768_2fc1016c0f54_TB2902_11 k_p = 11ea7fdb_fc73_470d_a768_133b2caeb618_TB2902_11 = 0.0833 Cost of common stock: k_e = k_F + β(k_M - k_F) k_e= .03 + 1.20(.05) k_e = 0.09 Step 3 - Compute the WACC. WACC = W_dK_d 11ea7fdb_fc73_6e1e_a768_0d549c346c58_TB2902_11 + W_pK_p + W_eK_e WACC = (0.40 × 0.045) + (0.05 × 0.0833) + (0.55 × 0.09) WACC = 0.018 + 0.00417 + 0.0495 = 0.0717 or 7.20%

As a Newly Hired Financial Analyst,your First Job at VersaLife