What is Lannister Manufacturing's WACC and Holdup Bank's cost of preferred stock?
Lannister Manufacturing has a target debt-equity ratio of 0.51, cost of equity is 18 percent, and its cost of debt is 10 percent. If the tax rate is 34 percent, then the company's WACC is 13.44 percent. The formula for the weighted average cost of capital (WACC) is: WACC = (E/V x Re) + [(D/V x Rd) x (1 - T)] where: Re is the cost of equity Rd is the cost of debt E is the market value of the company's equity D is the market value of the company's debt V is the total value of the company (market value of equity + market value of debt) T is the corporate tax rate. For Lannister Manufacturing, WACC = [(0.49 x 18%) + (0.51 x 10% x (1 - 34%))] x 100 WACC = 13.44% Therefore, the answer is option A, 13.44%. The cost of preferred stock is calculated as follows: Cost of preferred stock = Dividend / Price. Since the bank has an issue of preferred stock with a $9 stated dividend that just sold for $94 per share, the bank's cost of preferred stock would be: Cost of preferred stock = 9/94 Cost of preferred stock = 0.0957 or 9.57%. Therefore, the answer is option C, 9.57%.
Lannister Manufacturing's WACC Calculation
The company's WACC is calculated using the formula: WACC = (E/V x Re) + [(D/V x Rd) x (1 - T)]
Where:
- Re: Cost of equity = 18%
- Rd: Cost of debt = 10%
- E: Market value of equity
- D: Market value of debt
- V: Total value of the company
- T: Corporate tax rate = 34%
Substitute the values and calculate:
WACC = [(0.49 x 18%) + (0.51 x 10% x (1 - 34%))] x 100
WACC = 13.44%
Holdup Bank's Cost of Preferred Stock Calculation
The cost of preferred stock is calculated as: Cost of preferred stock = Dividend / Price
Given that the bank's preferred stock has a $9 stated dividend and sold for $94 per share:
Cost of preferred stock = 9 / 94
Cost of preferred stock = 0.0957 or 9.57%