Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital

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Asked Jul 24, 2019
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Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital

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Expert Answer

Step 1

Calculation of weights of three components:

 Excel spread sheet:

Note: Assumed $1,000 as par value

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A Market values Weight Particulars 1 2 Cost of preferred sharesS39,750,000 0.1769| з Bond 4 common stock 5 Total S80,000,000 0.3560| $105,000,000 0.4672| $224,750,000

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Step 2

Excel workings:

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A Market values Particulars 2 Cost of preferred shares |=750000*53 з Bond 4 common stock 5 Total Weight |-B2/B5 1 |=80000*1000 |=B3/B5 =2500000*42 =B4/B5 |=SUM(B2:B4)SUM(C2:C4)

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Step 3

Calculation of cost of common...

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on stock Risk-free rate +Beta x(Market retun - Risk-free rate Cost of com m =2.8%+1.34x (11.2%-2.8%) =14.056%

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