The Weighted Average Cost of Capital (WACC) for Magellan Corporation

  The Weighted Average Cost of Capital (WACC) for Magellan Corporation The Weighted Average Cost of Capital (WACC) is a measure that represents the average cost of financing the company’s assets. It is an important metric used by companies to determine the minimum return they need to generate to cover their financing costs. To compute the WACC for Magellan Corporation, we need to calculate the cost of each type of financing, taking into account the weight of each component in the capital structure. Cost of Debt The cost of debt is the interest rate that the company has to pay on its outstanding debt. In this case, Magellan Corporation has issued bonds with an 8% coupon rate. However, since flotation costs are 13% of market value, we need to adjust the cost of debt accordingly. The adjusted cost of debt can be calculated as follows: Adjusted Cost of Debt = Coupon Rate * (1 - Flotation Cost) Adjusted Cost of Debt = 8% * (1 - 0.13) Adjusted Cost of Debt = 6.96% Cost of Preferred Stock The cost of preferred stock is the dividend yield on the preferred stock. In this case, Magellan Corporation has issued preferred stock with a $1.50 dividend and a market price of $20 per share. The dividend yield can be calculated as follows: Dividend Yield = Dividend / Market Price Dividend Yield = $1.50 / $20 Dividend Yield = 7.5% Cost Common Equity The of common equity the return required by shareholders in exchange for their investment in the company’s common stock. can be calculated using Capital Asset Pricing Model (CAPM), which takes account the risk-free rate, the market risk premium, and the company’s beta. However, in this case, we are given the dividends for common stock and their estimated annual growth rate. We can use the Dividend Discount Model (DDM) to calculate the cost of common equity. Cost of Common Equity = Dividend / Market Price + Growth Rate Cost of Common Equity = $2.50 / $30 + 6% Cost of Common Equity = 13.33% Weighted Average Cost of Capital (WACC) To calculate the WACC, we need to multiply the cost of each component by its weight in the capital structure and sum them up. The formula for WACC is as follows: WACC = (Weight of Debt * Cost of Debt) + (Weight of Preferred Stock * Cost of Preferred Stock) + (Weight of Common Equity * Cost of Common Equity) WACC = (36% * 6.96%) + (19% * 7.5%) + (45% * 13.33%) WACC = 2.51% + 1.43% + 5.99% WACC = 9.93% Reasonableness of WACC The WACC for Magellan Corporation, calculated to be 9.93%, can be considered reasonable given the assumptions and other relevant information. Firstly, it is important to note that the WACC is lower than the return required by shareholders on their investment (cost of common equity), which indicates that the company is generating sufficient returns to cover its financing costs. Secondly, the WACC takes into account the tax rate of 34%, which reduces the overall cost of debt for the company. Lastly, the weights assigned to each component in the capital structure reflect the actual proportions used by Magellan Corporation to finance its operations. This ensures that the WACC accurately represents the average cost of capital for the company. In conclusion, based on the assumptions and other relevant information provided, the WACC of 9.93% for Magellan Corporation seems reasonable and provides a useful measure for evaluating investment opportunities and making financial decisions.

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