Question

A company has 3 million shares outstanding at a market price of $1.50 each. The company's bonds have a total market value of $2,700,000, have a coupon rate of 3% p.a. and currently yield 4% p.a. The current market value of preference shares is $500,000 and currently return 5% p.a. The company has a beta of 0.7, the market risk premium is 6% p.a., the risk-free return is 2% p.a., and the company tax rate is 30%,

What is the firm's weighted average cost of capital (WACC)?

Answer 1

Value of equity= 3,000,000 × 1.50 = 4,500,000

(+) Value of bond= 2,700,000

(+)Value of preference share = 500,000

Total market value = $7,700,000

Weight of equity= 4,500,000 / 7,700,000 = 0.5844

Weight of debt= 2,700,000 / 7,700,000 = 0.3506

Weight of preference share= 500,000 / 7,700,000 = 0.065

Cost of equity = Risk free rate + beta (market risk premium)

= 2% + 0.7 (6%)

= 2% + 4.2%

= 6.2%

Cost of debt after tax = ytm (1-tax rate)

= 4% (1-0.30)

= 4% (0.70)

= 2.8%

Cost of preference share = 5%

WACC= weight of debt × after tax cost of debt + weight of preference share × cost of preference share + weight of equity × cost of equity

= 0.3506 × 2.8% + 0.065 × 5% + 0.5844 × 6.2%

= 0.98% + 0.325% + 3.62%

= 4.93%