Question

BearKat wants to build a new assembly line to improve productivity. It is expected to generate a return of 17%. Sammy wants to know what he should use for his hurdle rate or WACC (weighted average cost of capital).
Sammy’s accountant provides you the following information.

Common stock is selling for $73 a share. The current annual dividend is $2.36 and the growth rate is expected to be 2% a year. The stock’s beta is 1.77.
Preferred stock sells for $123 and pays an annual dividend of $25.
There are currently 15 year callable, 3% coupon bonds available at a price of $988. The yield to maturity of these bonds is 3.1%.

There are 20 year, non-callable 5% coupon bonds that pay annual payments and are available at a price of $1,080. The yield to maturity of these bonds is 4.39%.
There are 5 year 7% coupon bonds that pay annual payments and are available at a price of $1,234. The yield to maturity of these bonds is 2.03%.

The bond-yield risk premium is 2%.
The current risk free rate is .5% and the market risk premium is 4%.
BearKat Autos has a target capital structure of 40% debt, 5% preferred stock and 55% common equity and their current tax rate is 25%.

16.) What is the (simple) average of the 3 above calculated costs of common equity values. Use this average as the eventual cost of common equity for Bearkat Autos.

A. 4.59%
B. 7.15%
C. 1.395
D. 6.42%

19.) What is the WACC for BearKat Autos (rounded to two decimal places, pick the closest one)?

A. 5.87%
B. 6.31%
C. 5.48%
D. 7.89%

Answer 1

Beta = 1.77, Market risk premium = 4. Risk Fre Rate =.5%

Therefore cost of equity = .5+ 1.77*4 = 7.58

Cost of equity = Dividend per share (for next year) / Share Price + gorowth Rate of Dividend

=2.36*1.02/73+.02 = 5.29%

Required Rate if return 17%

Cost of preferred stock= Dividends/ Net issuing price = 25/123 = 20.3%

The amount of debt taken not mentioned, in what proporation are these bonds taken. The par Value of each bond can be calulated and the coupon rate would be the cost of debt of hat bond.

WACC would be the weightted average of these costs