(a) A firm has a $250,000 (nominal value) bond issue outstanding that is selling at...
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(a) A firm has a $250,000 (nominal value) bond issue outstanding that is selling at 92 percent of face value. The coupon rate is 8% and the yield-to-maturity is 12%. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding. The preferred stock has a market price of $35 a share. The common stock has a price of $24 a share. The market return is 12%, the beta of the common stock is 1.8, and the risk-free rate is 5%. The preferred stock is expected to pay a constant annual dividend per share (forever) equal to $1.5, starting one year from now. The tax rate is 30%. What is the Weighted Average Cost of Capital?
(6 marks)
(b) How the WACC would change if the preferred stock is expected to pay a constant annual dividend per share of $1.5 starting one year from now and this dividend is expected to grow at the annual rate of 3%?
(2 marks)
(c) What role does the Weighted Average Cost of Capital play when determining a project's cost of capital? What happens if the firm uses the WACC for projects that are less risky than the overall firm?
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