Scenario: You work for an investment banking firm and have been asked by management of Vestor Corporation (not real), a software development company, to calculate its weighted average cost of capital, to use in evaluating a new company investment. The fir

  

Scenario: You work for an investment banking firm and have been asked by management of Vestor Corporation (not real), a software development company, to calculate its weighted average cost of capital, to use in evaluating a new company investment. The firm is considering a new investment in a warehousing facility, which it believes will generate an internal rate of return of 11.5%. The market value of Vestor's capital structure is as follows: 

  

Source of Capital

Market Value

 

Bonds

$10,000,000

 

Preferred Stock

$2,000,000

 

Common Stock

$8,000,000

To finance the investment, Vestor has issued 20 year bonds with a $1,000 par value, 6% coupon rate and at a market price of $950. Preferred stock paying a $2.50 annual dividend was sold for $25 per share. Common stock of Vestor is currently selling for $50 per share and has a Beta of 1.2. The firm's tax rate is 34%. The expected market return of the S&P 500 is 13% and the 10-Year Treasury note is currently yieldin what discount rate (WACC) Vestor should use to evaluate the warehousing facility project. 

Cost of debt = (1 – tax rate) so, 1 – 34% =.66 and using I/Y which = 6.45%, the equation is then 6.45% X .66 = 4.26%

cost of equity .035 + 1.2 (.13 - .035) .035 + 1.2(.095) = .149 = 14.9%