Question

You have been hired as a consultant by Aerospace Exploration, Inc.   (AEI).    AEI is publically traded company and a leader in space travel.   The company is looking to setup an outpost on the moon, where visitors can experience space living over a 2 week visit (including travel time).    AEI owns land which has a book value of $7.3 million and a market value of $7.5 million.   The following market data is available:

Debt: 260,000; 6.1% semi-annual coupon bonds outstanding with 25 years to maturity.   Current bond price is $1,040. Bond was issued at $1,000

Common stock: 9,900,000 shares outstanding with a current share price of $68/share.   Stock beta is 1.2

Preferred stock:   400,000 shares which pay $4.20 dividend.   Currently, selling at $87/share

Market: 7 percent expected market risk premium; 3.1 percent risk free rate; tax rate is 21%

Calculate the weighted average cost of capital (WACC).   (show all of your work)

WACC = w_d x R_d x (1 – T) + w_cs x R_cs + w_ps x R_ps

w_d = weight of debt       w_cs = weight of common stock   w_ps = weight of preferred stock

R_d = cost of debt (solve using TVM calculator i)

R_cs = cost of common stock (use CAPM )

R_ps = cost of preferred stock

Answer 1

WACC = wd x Rd x (1 – T) + wcs x Rcs + wps x Rps

wd = weight of debt       wcs = weight of common stock   wps = weight of preferred stock

Rd = cost of debt (solve using TVM calculator i)

Rcs = cost of common stock (use CAPM )

Rps = cost of preferred stock

We will calculate each of the components of WACC

Debt=260*1040=270,400<--MArket price of debt*no of bends issued

Equity=68*9,900,000=673,200,000

Preferred equity=400,000*87=34,800,000

Wd-weight of debt=Debt/(Debt+Equity+preferred), similarly weights of preferred and comman stock will also be calculated

	Value	Weight
Debt	270,400	0.04%	<--Wd
Preferred stock	34,800,000	4.91%	<--Wps
Equity	673,200,000	95.05%	<--Wcs
Total	708,270,400

Rd=Cost of debt=Current YTM on bond=5.8%<--I used the rate function on excel as i do not have a TVM calculator

Rcs=CAPM=Rf+Beta*(Rm-Rf)=3.1%+7%*1.2=11.5%

Rps=didivend/current price=4.83%<--4.2/87

	Weight	Rate	Weighted rate
Debt	0.04%	5.80%	0.00%	<--Rate*Weight*(1-21%)
Preferred stock	4.91%	4.83%	0.19%	<--Rate*weight
Equity	95.05%	11.50%	8.64%	<--Rate*weight
		Total	8.82%

Thus the WACC is 8.82%

Please reach out for any clarifications