Question

Suppose a company has 5 million common shares outstanding, which have a market value of $24...

Suppose a company has 5 million common shares outstanding, which have a market value of $24 per share. The most recent annual dividend paid was $2.25/share. The expectation is for an 8 percent constant growth of the firm’s earnings & dividends. The 3-year average yield on 10-year T-Bonds is 5.50%, the expected return on a broad index of common stocks is 11% and the stock is twice as variable as the market average. The capital structure includes also 150,000 15-year $1,000 par, 10 percent annual coupon bonds outstanding, currently selling for $862.35. The company is in the 35% tax bracket. What is the firm’s marginal weighted average cost of capital?

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Answer #1

value of equity = 5 million * 24 = 120 million

value of debt = 150000 * 862.35 = 129.3525 million

total value = 249.3525 million

cost of equity = risk free rate + beta * market risk premium

= 0.055 + 2 * (0.11-0.055)

= 16.5%

using excel rate function

YTM =

RATE(number_of_periods, payment_per_period, present_value, [future_value], [end_or_beginning], [rate_guess])

= RATE(15,1000*10%,-862.35,1000)

= 12.0236%

WACC = weight of debt * after tax cost of debt + weight of equity * cost of equity

= (129.3525/249.3525) * 12.0236% * (1-0.35) + (120/249.3525) * 16.5%

= 12%

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