Question

The CCC company has a long-term bond consists of 40,000 bonds, each with a par value of $1,000, an annual coupon rate of 8%, and a 20-year maturity. The current yield to maturity of the bonds is 11%. The common stock sells at a price of $20 per share. There are 1.5 million outstanding shares. The company’s perpetual preferred stock has a $100 par value, pays a quarterly dividend of $3.75, and has a yield to investors of 12%. There are 80,000 outstanding preferred stocks. The security analysts have reported the beta of the company as 2.2 and the market risk premium is estimated by various brokerage houses to be 5% and the average market return is 8%. The company’s tax rate is 20%.

Answer all of the following questions in percentage format without ‘%’ symbol.

a. What is W_d?

b. What is W_e?

c. What is W_p?

d. What is the after-tax cost of debt ?

e. What is the cost of equity based on CAPM model?

f. Find the company’s WACC.

Answer 1

first we have to calculate price of the bond

Coupon = 1000*8% = 80

number of periods = 20

YTM = 11%

[N = 20 ; I/Y = 11% ; PMT = 80 ; FV = $1000] compute for PV

Price = $761.10

Price of preference stock:

preference dividend / Price = Yield

annual dividend = 3.75*4 = 15

price = 15 / 12% = 125

d)

after tax cost of debt = 11*(1 - tax)

= 11*(1 - 0.20) = 8.80

e)

As per CAPM required return = Risk free rate + beta*(market return - risk free rate)

Risk free rate = 8% - 5% = 3%

Required return = 3% + 2.2*(5%)

= 14

a , b , c and f are as follows:

(NOTE : Please do not include % symbol while answering as per requirement)