The management of Microscam International, a large software manufacturer, is examining its capital structure. The firm is financed according to the following schedule based on market values:
40% debt
50% common stock
10% perpetual preferred stock
Additionally, consider the following information:
Yield on outstanding debt: 9.25%
Tax rate: 35%
Annual preferred dividend: $2.02
Preferred stock price: $17.44 -
Return on equity: 22%
Dividend payout ratio: 15%
Cost of common stock: 15.40%
Using this information, what is the Weighted Average Cost of Capital for Microscam?
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A. B. C. D. E. F.E
In order to calculate the WACC, it is necessary to first calculate the component after-tax cost of debt, common equity, and preferred equity. Once the cost of these components is determined, they are imputed into the WACC equation, which is as follows:
{WACC = [(% weight of debt securities * cost of debt) + (% weight of common stock * cost of common stock) + (% weight of preferred stock * cost of preferred stock)]}
To calculate the component cost of debt, use the following equation: {After-tax cost of debt = [yield on outstanding debt securities * (1 - tax rate)}
Factoring in the given information into this equation would yield the following:
{After-tax cost of debt = [9.25% * (1 - 0.35%)]} = 6.013%
To calculate the component cost of outstanding preferred stock, the following equation must be used:
{Cost of preferred stock = [annual dividend / preferred stock price]}
{Cost of preferred stock - = [$2.02 / $17.44]} = 11.58%.
The final component of the WACC calculation, the cost of common equity, has been provided as 15.40%.
Now that the after-tax cost of debt, preferred stock, and common stock have been determined, the WACC calculation can be found. The calculation of the WACC is as follows: {[0.40 * 0.06013] + [0.50 * 0.1540] + [0.10 * 0.1158]} = 11.263%.