Question

Caspian Sea Drinks' is financed with 67.00% equity and the remainder in debt. They have 11.00-year, semi-annual pay, 5.96% coupon bonds which sell for 98.44% of par. Their stock currently has a market value of $24.98 and Mr. Bensen believes the market estimates that dividends will grow at 3.79% forever. Next year’s dividend is projected to be $2.55. Assuming a marginal tax rate of 33.00%, what is their WACC (weighted average cost of capital)?

Answer 1

First we will calculate cost of debt

Cost of capital is yield to maturity of bond

Face value is 100

Market value is 98.44

Coupon rate is 5.96%

At market price of 5.96% Market value is 100

let us calculate market value at 7%

Market value of bond is present value of cash flows

= 2.98(PVIFA 3.5% 22P) + 100(PVIF 3.5% 22p)

= 2.98(15.1671) + 100(0.4692)

= 92.11

Now by using interpolation method we get ytm as

= 2.98%% - (100-98.44)×0.52)/(100-92.11) = 2.88% annualised is 5.7%

Tax rate is 33%

After tax cost of debt is 5.7(1-0.33) = 3.819%

Cost of equity can be calculated by dividend discount model

Price is 24.98

D1 = 2.55 growth = 3.79%

Ke= D1/p +g

= 2.55/24.98 + 0.0379 = 13.99%

Weight of equity is 67% weight of Debt is 33%

Weighted average cost of capital is

(13.99(67) + 3.819(33))/100 = 10.633%