Question

The Fresno Eastern Company (FEC) bond carries a coupon rate of 6% with semi-annual payments, a $1,000 par, and a maturity of 20 years. The current price of the bonds is $980. The firm’s average tax rate is 21%. What is its after-tax cost of bonds (debts)? Round the answers to 4 decimal places, e.g., 0.3216.

0.0489

Treasury bond currently yields 1.75% and the expected market return is 8%. FEC’s beta is 0.98. Please use the CAPM model to calculate FEC’s cost of common stock?

0.0783

FEC’ capital structure is as follows:
Bonds (2,000 bonds outstanding) $1,960,000
Common stock (500,000 shares) $5,000,000
Based on your calculation on its cost of debts and common stocks, what is FEC’s WACC (weighted average cost of capital)?

Answer 1

1)

Semi annual coupon = [(6 / 100) * 1000] / 2 = 30

Number of periods = 20 * 2 = 40

Yield to maturity = 6.1755%

Keys to use in a financial calculator:

2nd P/Y 2

FV 1000

PV -980

N 40

PMT 30

CPT I/Y

After tax cost of debt = YTM (1 - tax)

After tax cost of debt = 0.061755 (1 - 0.21)

After tax cost of debt = 0.0488

2)

Cost of common equity = Risk free rate + beta(marker return - risk free rate)

Cost of common equity = 0.0175 + 0.98(0.08 - 0.0175)

Cost of common equity = 0.0175 + 0.06125

Cost of common equity = 0.0788

3)

Total market value = 1,960,000 + 5,000,000

Total market value = 6,960,000

WACC = Weights * costs

WACC = (1,960,000 / 6,960,000)*0.0488 + (5,000,000 / 6,960,000)*0.0788

WACC = 0.01374 + 0.05661

WACC = 0.0704