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Cream and creamsin has a capital of 40% debt and 60% equity. Tax rate is 32%,...

Cream and creamsin has a capital of 40% debt and 60% equity. Tax rate is 32%, bonds trade for 784. Face value is 1,000 coupon rate is 8%, paid semiannual with 7 years to maturity. Common stocks are $15 per share, dividend just paid is 2% and will grow st 6% per year. What is the WACC?
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Answer #1

Using financial calculator: FV = 1000, PV = -784, Coupon = 40, N = 14

Compute I/Y = 6.38%

Annual I/Y = 6.38% x 2 = 12.76%

YTM is the cost of debt which in this case is 12.76%.

After - tax cost of debt = 12.76% (1 - 32%) = 8.68%

Current Dividend = 2% of 15 = $0.30

Next year's dividend = 0.30 (1 + 6%) = $0.318

Cost of equity= [ Next year's Dividends Price] + Growth% = [0.318 15] + 6% = 8.12%

WACC = Weight Equity x Cost of Equity + Weight Debt x After-tax cost of Debt

= 0.60 x 8.12% + 0.40 x 8.68%

WACC = 8.34%

Note: Here cost of equity (8.12%) is less than than cost of debt (8.68%). This usually doesn't happen in real life as equity is more riskier than debt and has higher rate of return.

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