CFA Practice Question

CFA Practice Question

A firm wishes to finance itself, and sells preferred stock, equity and bonds. It gets $2 million by selling preferred stock that will pay preferred dividends of $140,000 every year. It gets $10 million by selling equity that buyers expect will pay dividends of 4% and grow at 5% every year. It gets $8 million by selling 8-year 5.2% semiannual coupon of maturity value $10 million. The tax rate is 36%. What is the firm's WACC?
A. 7.43%
B. 5.98%
C. 6.57%
Explanation: First calculate the 6 month yield on the bond using your financial calculator. Next (1+r)2 - 1 to get the 12 month yield. Multiply by (1-tax rate) to get after tax cost of capital for debt. Cost of equity is dividend yield + growth rate. Cost of preferred stock is preferred dividends/price of preferred stock. Finally weight by market (not face) values of preferred stock, equity and debt to get WACC. This question may seem long and/or hard, but better to do this in practice than in the real exam!

User Contributed Comments 3

User Comment
Coowy PS 7% Value 2 Mio
CE 9% Value 10 Mio
DEBT 5.58% Value 8 Mio
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WACC 7.43%
prabvja coowy,
could you specify more on how you got 5.58% for DEBT please?
sheridanla I/Y= 4.36; with N=16; PV=800,000; PMT=260,000; FV=10,000,000

Cost of debt=(1-0.36)*(2*0.0436)=0.0558
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