Important notes to know:
The after cost of debt (ACOB) is calculated as follows:
ACOB= BCOB * (1- tax rate), where the BCOB is the before cost of debt and the ACOB is the after cost of debt. The BCOB is 8% same as the coupon rate. The tax rate is 35% same as 0.35.
Hence, ACOB= 8 * (1-0.35) = 8 * (0.65) = 5.2
Cost of preferred stock = Dividend preferred / Preferred stock’s market price where the dividend preferred is $2.5 and the preferred stock’s market price is $25.
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Hence, Cost of preferred stock = 2.5 / 25 = 10%
Common stocks’ cost = + growth rate
Common stocks’ cost = + 0.05 = 0.125 = 12.5%
According to the above calculations, 12.5% is the cost of equity. The basis of the cost of equity is dependent on $1.50 per share in the upcoming year. The new selling price for every share is $20.00. The growth rate is 5%. It is also notable that the cost of the capital is taken as 27.73% that is based on the 35% tax rate, 50% common stock, 45% debt cost, preferred stock as 5% and 12.5% as the cost of equity.
QN. If Bad Boys, Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys, Inc.’s cost of capital?
Solution
WACC is calculated through the multiplication of every capital source by the relevant weight, then doing the addition of the total products to get the value. The calculations are as follows:
Debt = Weight * Cost, where the weight is taken as 45% treated as 0.45
Debt = 0.45 * 5.2 = 2.34
Preferred stock = Weight * Cost, where the weight is taken as 5% treated as 0.05
Preferred Stock = 0.05 * 10 = 0.5
Common stock = Weight * Cost, where the weight is taken as 50% treated as 0.5
Common stock = 0.5 * 12.5 = 6.25
WACC = Total of all weights * Cost
WACC = Debt + Preferred stock + Common stock
WACC = 2.34 + 0.5 + 6.25 = 9.09
Hence, Bad Boys, Inc.’s cost of capital is 9.09
QN. If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common stock, what is Bad Boys, Inc.’s cost of capital?
Solution
WACC is calculated through the multiplication of every capital source by the relevant weight, then doing the addition of the total products to get the value.
The calculations are as follows:
Debt = Weight * Cost, where the weight is taken as 30% treated as 0.3
Debt = 0.3 * 2.34 = 0.702
Preferred stock = Weight * Cost, where the weight is 5% treated as 0.05
Preferred Stock = 0.05 * 10 = 0.5
Common stock = Weight * Cost, where the weight is 65% treated as 0.65
Common stock = 0.65 * 12.5 = 8.125
WACC = Total of all weights * Cost
WACC = Debt + Preferred stock + Common stock
WACC = 0.702 + 0.5 + 8.125 = 9.327
Hence, Bad Boys, Inc.’s cost of capital is 9.327
