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Royalty Products has 140,000 shares of common stock outstanding at a market price of $27 per share. Next year's annual dividend is expected to be $1.43 per share, and the dividend growth rate is 2 percent. The company also has 2,500 bonds outstanding with a face value of $1,000 per bond. The bonds have a pretax yield of 7.35 percent and sell at 98.2 percent of face value. The company's tax rate is 21 percent. What is the weighted average cost of capital (WACC)?

Remember to show all work for each step, from setting up formulas to the final result, to receive credit.

Answer :

We must take into account the cost of debt and equity when calculating the weighted average cost of capital (WACC). The average rate of return a business must produce is known as the WACC.

We must take both the cost of equity and the cost of debt into account when calculating the weighted average cost of capital (WACC). The WACC is the typical rate of return a business must produce to satisfy its investors' expectations. Here's a step-by-step calculation that we can perform:

1. Calculate the cost of equity (Ke):

Ke = (Dividend per share / Market price per share) + Dividend growth rate

Dividend per share = $1.43

Market price per share = $27

Dividend growth rate = 2% (convert to decimal by dividing by 100)

Ke = ($1.43 / $27) + 0.02

2. Calculate the cost of debt (Kd):

Kd = Pretax yield * (1 - Tax rate)

Pretax yield = 7.35% (convert to decimal by dividing by 100)

Tax rate = 21% (convert to decimal by dividing by 100)

Kd = 0.0735 * (1 - 0.21)

3. Calculate the weight of equity (We):

We = Total equity / Total capital

Number of shares * Market price per share equals total equity.

Number of shares = 140,00

Market price per share = $27

We = (140,000 * $27) / (140,000 * $27 + Total debt)

4. Calculate the weight of debt (Wd):

Wd = Total debt / Total capital

Total debt = Number of bonds * Bond face value * Bond selling price

Number of bonds = 2,500

Bond face value = $1,000

Bond selling price = 98.2% (convert to decimal by dividing by 100)

Wd = (2,500 * $1,000 * 0.982) / (140,000 * $27 + 2,500 * $1,000 * 0.982)

5. Calculate the WACC:

(Ke * We) + (Kd * Wd) = WACC

Substitute the values we calculated in steps 1-4 to calculate the WACC.

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