The following market information was gathered for the Blender Corporation.The firm has 1,000 bonds outstanding,each selling for $1,100.00 with a required rate of return of 8.00%.Blenders has 5,000 shares of preferred stock outstanding,selling for $40.00 per share and 50,000 shares of common stock outstanding,selling for $18.00 per share.If the preferred stock has a required rate of return of 11.00% and the common stock requires a 14.00% return,and the firm has a corporate tax rate of 30%,calculate the firm's WACC adjusted for taxes.

Question

Quizplus · Accepted Answer

To calculate the WACC, we need to first calculate the cost of each source of financing (bonds, preferred stock, common stock) and then weight them based on their proportion in the company's capital structure.

For the bonds, we have the following information:

Number of bonds outstanding: 1,000
Selling price per bond: $1,100
Required rate of return: 8.00%

Using the formula for the cost of debt, we get:

Cost of debt = (Interest expense / (1 - Tax rate)) / Bond price
Interest expense = (1,000 bonds x $1,000 face value x 8.00%) = $80,000
Tax rate = 30%
Bond price = $1,100

Cost of debt = ((80,000 / (1 - 0.30)) / 1,100) = 6.36%

For the preferred stock, we have the following information:

Number of preferred shares outstanding: 5,000
Selling price per share: $40.00
Required rate of return: 11.00%

Using the formula for the cost of preferred stock, we get:

Cost of preferred stock = Preferred dividend / Preferred price
Preferred dividend = 5,000 shares x $40.00 x 0.11 = $22,000
Preferred price = $40.00

Cost of preferred stock = 22,000 / (5,000 x 40) = 13.75%

For the common stock, we have the following information:

Number of common shares outstanding: 50,000
Selling price per share: $18.00
Required rate of return: 14.00%

Using the CAPM formula, we get:

Cost of common stock = Risk-free rate + Beta x (Market return - Risk-free rate)
Risk-free rate = 3.00% (assumed)
Market return = 10.00% (assumed)
Beta = 1.50 (assumed based on industry average)

Cost of common stock = 3.00% + 1.50 x (10.00% - 3.00%) = 12.00%

Now we can calculate the WACC using the weights of each source of financing:

Proportion of debt = (1,000 x $1,100) / ($1,100 x 1,000 + $40 x 5,000 + $18 x 50,000) = 0.0181
Proportion of preferred stock = ($40 x 5,000) / ($1,100 x 1,000 + $40 x 5,000 + $18 x 50,000) = 0.0372
Proportion of common stock = ($18 x 50,000) / ($1,100 x 1,000 + $40 x 5,000 + $18 x 50,000) = 0.9447

WACC = (0.0181 x 6.36%) + (0.0372 x 13.75%) + (0.9447 x 12.00%) = 9.53%

Therefore, the correct answer is (C) 9.53%.

The Following Market Information Was Gathered for the Blender Corporation