Question

Your company is estimating its WACC. Its target capital structure is 35 percent debt, 10 percent preferred stock, and 55 percent common equity. Its bonds have a 10 percent coupon, paid semi-annually, $1000 par value, a current maturity of 8 years, and sell for $950. The firm’s preferred stock sell for $75 and pay quarterly dividend of $2. This company’s beta is 1.25, the risk-free rate is 4 percent, and the expected market return is 9 percent. The firm's marginal tax rate is 30 percent. What is the WACC of this company?

Answer 1

WACC=(weight of debt*after tax cost of debt)+(weight of preferred stock*cost of preferred stock)+(weight of equity*cost of equity)

before tax cost of debt has to be found using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

the payments are semi-annual

nper=2*8=16

pmt=semi-annual coupon=(10%*1000)/2=50

pv=950

fv=1000

=RATE(16,50,-950,1000,0)=5.477%

Annual yield maturity=2*5.477%=10.95%

before tax cost of debt=10.95%

After tax cost of debt=before tax cost of debt*(1-tax rate)=10.95%*(1-30%)=7.67%

Cost of preferred stock=annual dividend/Price of preferred stock=(4*2)/75=8/75=10.67%

Cost of equity=risk free rate+(Beta*(market return-risk free rate))=4%+(1.25*(9%-4%))=10.25%

WACC=(35%*7.67%)+(10%*10.67%)+(55%*10.25%)=9.39%