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Gul Corp. considers the following capital structure optimal: 40% debt; 50% equity; and 10% preferred stock. Gul’s stock currently sells for $50 per share. Gul’s beta is 1.8. The risk-free rate is 9 percent and the expected market return is 13 percent. Gul’s bond currently sells in the market for $1150. The bond carries an annual coupon payment of 12 % of the face value which is paid in two semiannual payments. The bond will mature in 15 years and its face value is $1000. The bond's annual yield to maturiy is 10.04%. The firm’s marginal tax rate is 40 percent. The Gul’s required return on the preferred stock is 13%. Find the firm’s overall cost of capital (WACC).

Answer :

TomShelby

Answer:

WACC 11.80960%

Explanation:

For the cost of capital we will use the CAPM model

[tex]Ke= r_f + \beta (r_m-r_f)[/tex]  

risk free 0.09

market rate 0.13

premium market = (market rate - risk free) = 0.04

beta(non diversifiable risk) 1.8

[tex]Ke= 0.09 + 1.8 (0.04)[/tex]  

Ke 0.162 = 16.2%

Then we can calculate the WACC

[tex]WACC = K_e(\frac{E}{E+P+D}) + K_p(\frac{P}{E+P+D}) + K_d(1-t)(\frac{D}{E+P+D})[/tex]

Ke=cost of capital= 0.162 (according to CAPM)

Equity weight =0.5

Kp= return on preferredstock = 0.13

Preferred Weight = 0.1

Kd= we use the actual market rate for the bebt = 10.04% = 0.1004

Debt Weight = 0.4

tax-rate = 40% = 0.4

[tex]WACC = 0.162(0.5) + 0.13(0.1) + 0.1004(1-0.4)(0.4)[/tex]

WACC 11.80960%

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