Question

After resolving the problem as stated above, for calculating correctly the cost of the ordinary share in your cafe businesses, you set a dividend policy with an average growth rate of 5.27 per cent that you plan to keep forever. You recently hired a business appraiser to estimate the value of your shares, which includes all of the 98 million outstanding ordinary shares. Her report indicates that they are worth $514 million. The appraiser reports that the beta of the company is 1.39.  

In order to finance 1,875 restaurants that are now part of your company, you have issued two different bonds 5 years ago. 200,000 outstanding 15-year 9.3% Bond-K with $1000 face value is currently selling at $1,221. On the other hand, 750,000 outstanding 20-year 10.1% Bond-Q with $200 face value is currently yielding 9.1 per cent.

You company has 12 million outstanding 12.5 per cent preference shares of $5 issue price. Preference shares are currently selling at $6.56 per share. Interest is compounded monthly for 11.9 per cent loan (long term) of $32.

Market expect 18.5 per cent return from shares of this cafe business. Tax rate is 34 per cent.

1. Estimate the WACC for this Cafe business.

Answer 1

WACC stands for the Weighted Average Cost of Capital.

The formula for WACC = Weight(debt)*k(d)(1-tax rate)+Weight(ordinary)*k(e)+Weight(Preference)*k(p)

Total no.of ordinary shares= 98 million

Total no of debt bonds=950000 (200000+750000) or 0.95 million.

Total no of preference shares=12 million

Weight of debt= (.95/98+.95+12) million= 0.00087

Weight of ordinary shares= (98/98+.95+12)million=0.8832

Weight of preference= (12/98+.95+12)million= 0.1081

tax rate=34%

Cost of Debt(k(d))=11.9%

Cost of Ordinary shares(k(e))=18.5%

Cost of Preference(k(p))=12.5%

Therefore, WACC= 0.0087*11.9%*(1-34%)+0.8832*18.5%+0.1081*12.5%

Therefore, WACC= 17.75878%