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The corporation is financed with debt, preferred equity, and common equity with market values of $20 million, $10 million, and $30 million, respectively. The betas for the debt, preferred stock, and common stock are 0.2, 0.5, and 1.1 respectively. If the risk rate is 3.95 percent, the market risk premium is 6.01 percent, and corporate average and marginal tax rates are both 30 percent, what is company's weighted average cost of capital (in percent)?

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Hubert Koch
Hubert KochLv2
29 Sep 2019

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Part A: ABC's capital structure is limited to common equity and bonds. Its target capital structure calls for 69 percent common equity and the rest long term debt. The company's outstanding bonds have a yield to maturity of 3.9 percent. The market risk premium for the average common stock is 11 percent, and the risk-free rate on US Treasuries is 5.3. ABC's beta is 1.47. Given its tax rate of 40 percent, what is ABC's weighted average cost of capital? (Show your answer in decimal for to three places, e.g., 12.3% would be entered as 0.123)

Part B:

MNO's capital structure includes bonds, preferred stock, and common stock. The target capital structure calls for 42 percent common stock, 10 percent preferred stock, and the remainder as bonds. The company's bonds have a yield to maturity of 7.5 percent. The company's preferred stock, which sells for $53.09 per share, pays an annual dividend of $4.74. The market risk premium for the average common stock is 10.4 percent and the risk-free rate is 2.1 percent. MNO stock has a beta of 1.4. If MNO's marginal tax rate is 40 percent, then what is MNO's weighted average cost of capital? (Show your answer in decimal for to three places, e.g., 12.3% would be entered as 0.123)

Match the Weighted Average Cost of Capital to each of the scenarios given for ABC Corporation.

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Target capital structure: 64% debt, 8% preferred stock and 28% common equity. Yield to maturity on bonds: 4.0%; Preferred stock dividend: $7.44 per year; current market price of preferred stock is $69.94. CAPM data for common equity: risk-free rate is 3.3%; market risk premium for the average stock is 5.6%; ABC has a beta of 1.88. ABC's marginal tax rate is 40%.
- A. B. C. D. E.

Target capital structure: 71% debt, 6% preferred stock and 23% common equity. Yield to maturity on bonds: 8.8%; Preferred stock dividend: $6.25 per year; current market price of preferred stock is $68.75. CAPM data for common equity: risk-free rate is 4.9%; market risk premium for the average stock is 7.5%; ABC has a beta of 0.92. ABC's marginal tax rate is 40%.
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Target capital structure: 59% debt, 9% preferred stock and 32% common equity. Yield to maturity on bonds: 6.2%; Preferred stock dividend: $6.07 per year; current market price of preferred stock is $68.57. CAPM data for common equity: risk-free rate is 3.4%; market risk premium for the average stock is 9.9%; ABC has a beta of 0.82. ABC's marginal tax rate is 40%.
- A. B. C. D. E.

Target capital structure: 69% debt, 7% preferred stock and 24% common equity. Yield to maturity on bonds: 8.6%; Preferred stock dividend: $6.14 per year; current market price of preferred stock is $68.64. CAPM data for common equity: risk-free rate is 3.3%; market risk premium for the average stock is 10.5%; ABC has a beta of 0.79. ABC's marginal tax rate is 40%.
- A. B. C. D. E.

Target capital structure: 51% debt, 12% preferred stock and 37% common equity. Yield to maturity on bonds: 5.3%; Preferred stock dividend: $6.71 per year; current market price of preferred stock is $69.21. CAPM data for common equity: risk-free rate is 4.3%; market risk premium for the average stock is 4.5%; ABC has a beta of 1.84. ABC's marginal tax rate is 40%.
A.

7.44%
B.

7.01%
C.

6.97%
D.

6.26%
E.

6.68%

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Target capital structure: 42% debt, 14% preferred stock and 44% common equity. Yield to maturity on bonds: 8.5%; Preferred stock dividend: $7.90 per year; current market price of preferred stock is $70.40. CAPM data for common equity: risk-free rate is 3.7%; market risk premium for the average stock is 8.1%; ABC has a beta of 1.35. ABC's marginal tax rate is 40%.
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Target capital structure: 33% debt, 10% preferred stock and 57% common equity. Yield to maturity on bonds: 5.5%; Preferred stock dividend: $7.41 per year; current market price of preferred stock is $69.91. CAPM data for common equity: risk-free rate is 3.3%; market risk premium for the average stock is 12.9%; ABC has a beta of 0.81. ABC's marginal tax rate is 40%.
A.

9.99%
B.

9.83%
C.

10.59%
D.

10.26%
E.

10.15%

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