ABC's current book value capital structure is: Bonds $40 million (Number of bonds outstanding= 40,000) (Coupon rate= 10% per annum) (Coupon payments annual, the face value= $1,000) (Remaining maturity= 16 years) Common Stock $50 million (Number of shares outstanding= 2million) Retained earnings $10 million The current yield to maturity of the firm's bonds is 7%. The current dividends per share= $2.5 and the growth rate of the dividends stream is 4% per annum and into indefinite future. The current required expected rate of return on the firm's common stock is 11% per annum. The corporate tax rate is 0.3. Using the market value weights, calculate the weighted average cost of capital of ABC Ltd.
Current Market Of Stock:
pE = D1/(rE - g) = [$2.5 x 1.04] / [0.11 - 0.04] = $2.6 / 0.07 = $37.14
Market Value of Equity = [Current Market Price x No. of stocks outstanding] + Retained Earnings
= [$37.14 x 2,000,000] + $10,000,000 = $74,285,714.29 + $10,000,000 = $84,285,714.29
To find the current market price of the bond, we need to put the following values in the financial calculator:
So, Market Value of Debt = [Current Market Price x No. of bonds outstanding]
= $1,283.40 x 40,000 = $51,335,978.32
Total Market Value = $84,285,714.29 + $51,335,978.32 = $135,621,692.60
wD = Market Value of Debt / Total Market Value = $51,335,978.32 / $135,621,692.60 = 37.85%
wE = Market Value of Equity / Total Market Value = $84,285,714.29 / $135,621,692.60 = 62.15%
WACC = [wD x kD x (1 - t)] + [wE x kE] = [0.3785 x 7% x (1 - 0.30)] + [0.6215 x 11%] = 2.65% + 6.84% = 9.49%
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