The weighted average cost of capital (WACC) is calculated using the firm's target capital structure together...

Transcribed Image Text:

The weighted average cost of capital (WACC) is calculated using the firm's target capital structure together with its after-tax cost of long-term debt, after-tax cost of short-term debt, cost of preferred stock, and cost of common equity. WACC = Weighted average cost of capital = Wara(1-T) + Wsta(1-T)rstd + Wps ps +Ws T's A firm's target capital structure consists of the following capital structure. Using the relevant costs calculated previously, what is the firm's weighted average cost of capital? T= 25% Wstd= 4% Estd Wd= 20% rd= Wps 2% T'ps= W = 74% r = Pre-tax cost of capital source, ri: After-tax cost of debt, (1-T)(r): Cost of capital component for WACC: Target capital structure weight, w: Weighted component cost: WACC = Sources of Capital Short- term Debt Long-term Preferred Common Debt Stock Stock 0% = Sum 0.00% = Sum Figure 9-1 MicroDrive, Inc.: Selected Capital Structure Data (Millions of Dollars, December 31, 2019) Investor-Supplied Capital Book Market Target Percent Book Percent Market Percent Liabilities and Equity of Total Value of Total Value of Total Capital Structure Accounts payable $ 200 5.5% Notes payable 150 4.2% $ 150 5.0% $ 150 5.7% Wstd= 4% Accruals 400 11.1% Total C.L. $ 750 20.8% Long-term debt 520 14.4% 520 17.3% 520 19.8% Wd= 20% Total liabilities $1,270 35.2% Preferred stock 100 2.8% 100 3.3% 100 3.8% Wps= 2% Common stock 500 13.9% Retained earnings 1,740 48.2% Total common equity Total $2,240 62.0% $2,240 $3,610 100.0% $3,010 74.4% 100.0% $1,860 $2,630 70.7% 100.0% W = 74% 100% Other Data (Millions, except per share data): Number of common shares outstanding = Price per share of common stock = Number of preferred shares outstanding = Price per share of preferred stock = Coupon rate on preferred stock = Flotation cost for issuing preferred stock = $100.00 7.00% 2.10% 60 Coupon rate on long-term debt = 10.00% $31.00 Par long term debt = $1,000 1 Market value long term debt = Interest rate on short-term debt = $1,200 6.00% Risk-free rate = 5.02% Beta = 1.33 Market risk premium= 6.00% Tax rate = 25% Notes: 1. The market value of the notes payable is equal to the book value. Existing long term bonds have a maturity of 15 years and 10% semi-annual coupon (par of $1,000) that is currently traded at $1,200. 2. The common stock price is $31 per share. There are 60 million shares outstanding, for a total market value of equity of $31(60) = $1,860 million. 3. The preferred stock price is $100 per share. There are 1 million shares outstanding, for a total market value of preferred of $100(1) = $100 million. The weighted average cost of capital (WACC) is calculated using the firm's target capital structure together with its after-tax cost of long-term debt, after-tax cost of short-term debt, cost of preferred stock, and cost of common equity. WACC = Weighted average cost of capital = Wara(1-T) + Wsta(1-T)rstd + Wps ps +Ws T's A firm's target capital structure consists of the following capital structure. Using the relevant costs calculated previously, what is the firm's weighted average cost of capital? T= 25% Wstd= 4% Estd Wd= 20% rd= Wps 2% T'ps= W = 74% r = Pre-tax cost of capital source, ri: After-tax cost of debt, (1-T)(r): Cost of capital component for WACC: Target capital structure weight, w: Weighted component cost: WACC = Sources of Capital Short- term Debt Long-term Preferred Common Debt Stock Stock 0% = Sum 0.00% = Sum Figure 9-1 MicroDrive, Inc.: Selected Capital Structure Data (Millions of Dollars, December 31, 2019) Investor-Supplied Capital Book Market Target Percent Book Percent Market Percent Liabilities and Equity of Total Value of Total Value of Total Capital Structure Accounts payable $ 200 5.5% Notes payable 150 4.2% $ 150 5.0% $ 150 5.7% Wstd= 4% Accruals 400 11.1% Total C.L. $ 750 20.8% Long-term debt 520 14.4% 520 17.3% 520 19.8% Wd= 20% Total liabilities $1,270 35.2% Preferred stock 100 2.8% 100 3.3% 100 3.8% Wps= 2% Common stock 500 13.9% Retained earnings 1,740 48.2% Total common equity Total $2,240 62.0% $2,240 $3,610 100.0% $3,010 74.4% 100.0% $1,860 $2,630 70.7% 100.0% W = 74% 100% Other Data (Millions, except per share data): Number of common shares outstanding = Price per share of common stock = Number of preferred shares outstanding = Price per share of preferred stock = Coupon rate on preferred stock = Flotation cost for issuing preferred stock = $100.00 7.00% 2.10% 60 Coupon rate on long-term debt = 10.00% $31.00 Par long term debt = $1,000 1 Market value long term debt = Interest rate on short-term debt = $1,200 6.00% Risk-free rate = 5.02% Beta = 1.33 Market risk premium= 6.00% Tax rate = 25% Notes: 1. The market value of the notes payable is equal to the book value. Existing long term bonds have a maturity of 15 years and 10% semi-annual coupon (par of $1,000) that is currently traded at $1,200. 2. The common stock price is $31 per share. There are 60 million shares outstanding, for a total market value of equity of $31(60) = $1,860 million. 3. The preferred stock price is $100 per share. There are 1 million shares outstanding, for a total market value of preferred of $100(1) = $100 million.