How did you get 7.1% as pre tax cost of debt? Interest of 6.9% applies to par value, not market price. So $69 x 70% = $48.30 / $1,044 = 4.626% after tax cost of debt.
Preferred pays 1.94 / 24.59 = 7.89%
Common - Rate = Next Div 3.21 / 55.54 = 5.78% + 4.9% = 10.68%
Weight: Debt 37.8%, Preferred 12.6%, Common 49.6%
You have the correct formulas and there is something wrong with either the answers or the data. Bonds for example should be 4.5/11.9, etc..
Weighted average Cost of Capital
As a member of the finance department for Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm’s present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm’s capital structure as follows:
Source of Capital Market Values
Bonds $4,500,000
Preferred Stock $1,500,000
Common Stock $5,900,000
To finance the purchase, Ranch Manufacturing will sell 10-year bonds paying 6.9% per year at the market price of $1,044. Preferred stock paying a $1.94 dividend can be sold for $24.59. Common stock for Ranch Manufacturing is currently selling for $55.54 per share and the firm paid a $3.06 dividend last year. Dividends are expected to continue growing at a rate of 4.9% per year into the indefinite future. If the firm’s tax rate is 30%, what discount rate should you use to evaluate the equipment purchase?
Ranch manufacturing’s WACC is __%
I got most of the problem:
1st – (Before tax cost of debt) 1,000 par, 10 years, 7.1% per year with market value of 1,049 is 6.42%
2nd – (After tax cost of debt) 6.42% x (1-30) = 4.494
3rd – Cost of Capital from Common Equity 2.99x(1+5.1%)/54.32 = 10.885%
4th – Preferred Stock cost = $2.04/$24.48=0.08333
But cant figure out where the figures from the “Weight” column came from?
Weight After Tax Cost of Financing Product
Debt 0.2823 0.04495 0.012686
Preferred 0.1935 0.08333 0.01613
Common 0.5242 0.0885 0.057059
WACC % 8.587
They say that the equation is Debt/Debt+ Preferred Stock+ Common Stock
Preferred/Debt+ Preferred Stock+ Common Stock
Common/Debt+ Preferred Stock + Common Stock
But this isnt working for me? Can you help me figure the Weighted Column.
