Reference no: EM13390563

Assume that you are the assistant to the CFO of XYZ Company.  Your task is to estimate XYZ's WACC using the following data:

• The firm's tax rate is 40%.

• The current price of the 12% coupon, semiannual payment, non-callable bonds with 15 years to maturity is $1,153.72.  New bonds could be issued with no flotation costs.

• The current price of the firm's 10% $100 par value, quarterly dividend, perpetual preferred stock is $116.95.  The flotation costs on a new issue would be 5% of the proceeds.

• The current price of the common stock is $50 per share.  The last dividend was $4.19, and dividends are expected to grow at a constant rate of 5%.  The firm's beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is 6%.

• he target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.

Procedure

•     What sources of capital should be included when you estimate XYZ's WACC?

•     Should the component costs be estimated on a before or after-tax basis? Why?
•     Should the component costs be historical or marginal costs? Why?

•     What is the market interest rate on XYZ's debt and its component cost of debt?

•     What is the firm's cost of preferred stock?

•     Why is the firm's cost of preferred stock lower than the yield to maturity on its debt (Hint: Think about taxes.)

•     What are the two primary ways that firms raise common equity?

•     XYZ does not plan to sell common stock.  Using the CAPM approach, what is the firm's cost of common equity?

•     What is the firm's WACC?