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To find the weighted average cost of capital (WACC) given the data above, you can use the following formula: WACC = (E/V) * Re + (D/V) * Rd(1-T) + (P/V) * Rp Where E is the market value of equity, D is the market value of debt, P is the market value of preferred stock, V is the total market value of the firm’s capital, Re is the cost of equity, Rd is the cost of debt, Rp is the cost of preferred stock, and T is the corporate tax rate.
First, we’ll need to calculate the market value of debt, equity, and preferred stock:
D = $950 million (market value of debt) P = $500 million * $96.20 (preferred share price) = $48,100 million (market value of preferred stock) E = ($900 million (common stock) + $20 million (leased assets) + $750 million (retained earnings)) = $1,670 million (market value of equity) V = E + D + P = $1,670 million + $950 million + $48,100 million = $2,668.1 million (total market value of the firm’s capital)
Next, we’ll need to calculate the cost of debt: Rd = 8% (debt coupon) * (1-0.40) (tax rate) = 4.8%
You can calculate the cost of preferred stock by using Rp = Dividend/Share price Rp = 9/96.2 = 0.0938
The cost of equity can be found using the Gordon Growth Model Re = D1/P + g = (1.15 + (0.085*25.50))/25.50 = 0.1204
Now we can plug in the values into the WACC formula WACC = (E/V) * Re + (D/V) * Rd(1-T) + (P/V) * Rp WACC = ($1,670 million / $2,668.1 million) * 0.1204 + ($950 million / $2,668.1 million) * 4.8% + ($48,100 million / $2,668.1 million) * 0.0938 WACC = 10.2%
If Company X wants to lower its WACC, it could consider several options such as: • Increasing the proportion of debt in its capital structure. As debt costs are generally less than equity, this would reduce the WACC. However, this option would also increase the risk of financial distress and may limit the company’s ability to raise additional funds in the future. • Increasing the proportion of preferred stock in its capital structure. As preferred stock costs more than equity, this would lower the WACC. It should consider the potential dilution to equity owners. • Lowering its corporate tax rate. The interest paid on the debt would be exempt from tax, lowering the WACC. • Lowering the leased assets’ interest rate by renegotiating the lease terms. • Increase the dividend payment and growth rate. This will raise the stock price. It’s important to note that any changes made to the capital structure should be evaluated in light of the company’s overall financial goals and risk tolerance.
