Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 7.5%. The company also has 750,000 shares of 7% preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $65 a share. The common stock has a beta of 1.34 and sells for $42 a share. The cost of equity is 14.06%. The corporate tax rate is 38%. What is the firm's weighted average cost of capital?

a. 10.15%

b. 10.64%

c. 11.18%

d. 1.30%

A) 10.15%

Explanation:

Cost of equity (Re) = 14.06% or 0.1406

cost of preferred stock (Rp) = 7/65 = 0.10769

cost of bonds (Rb) = 7.5% or 0.075

outstanding shares = 2.5 million shares x $42 = $105 million

bonds outstanding = $1,000 x 80,000 bonds = $80 million

preferred stock = $65 x 750,000 = $48.75 million

corporate tax rate = 38% or 0.38

total market value of equity + debt (in millions) = $105 + $48.75 + $80 = $233.75

WACC = [ (outstanding shares / total market value) x Re] + [ (preferred stock / total market value) x Rp] + {[ (bonds outstanding / total market value) x Rb] x (1 - tax rate) }

WACC = [ ($105m / $233.75m) x 0.1406] + [ ($48.75m / $233.75m) x 0.10769] + {[ ($80m / $233.75m) x 0.075] x (1 - 0.38) }

WACC = 0.06316 + 0.02246 + 0.01591 = 0.10153 or 10.15%