Debbie's Donuts has 200,000 shares of common stock outstanding, which have a current market price of $25 a share. This year's annual dividend is expected to be $3.50 per share, with a growth rate of 2.5%. The firm also has 10,000 bonds outstanding with a yield to maturity of 6%. The bonds have a face value of $1,000 per bond, and are currently selling at 102% of par. If Debbie's donuts has a tax rate of 30%, what is the weighted average cost of capital?

8.36%

Explanation:

Data provided in the question:

Number of stocks outstanding = 200,000

Current market price = $25

Dividend paid, D1 = 3.5

Growth rate = 2.5% = 0.025

Bonds outstanding = 10,000

Yield to maturity = 6%

Current selling price = 102% of par

Now,

Total value of Common stock

= Number of stocks outstanding * Market price

= 200,000 * $25

= $5 million

Cost of equity = (D1 : Current price) + Growth rate

= [ (3.5 * (1 + 0.025)) : 25 ] + 0.025

= 16.85%

Total value of bonds = 10000 * (1000 * 102) %

= $10.2 million

After-tax cost of debt = yield to maturity * (1 - tax rate)

= 6 * (1 - 0.3)

= 4.2%

Total value = (5 + 10.2)

= $15.2 million

WACC = Respective costs * Respective weight

= (5 : 15.2) * 16.85 + (10.2 : 15.2) * 4.2

= 8.36%