Question

You are given the following Information: Assume the companys tax rate is 35%, debt: 12,000 5% coupon bonds outstanding, $1000 par value, 25 yers to maturtiy, selling for 98% of par, the bonds make semiannual payments.

Common stock : 525,000 shares outstanding, selling for $58 per share, the beta is 0.98

Preffered stock: 35,000 shares of 3.5% preferred stock outstanding, selling for $69 per share

Market: 8% market risk premium and 3.5% risk free rate. use the approximate formula to calculate the cost of debt. (do not use financial calculator to calculate cost of debt)

what is the companys WACC? (do not round intermediate calculations. enter your answer as a percentage rounded to 2 decimal places.)

Answer 1

Debt:

Number of bonds outstanding = 12,000
Face Value = $1,000
Current Price = 98%*$1,000 = $980

Value of Debt = 12,000 * $980
Value of Debt = $11,760,000

Annual Coupon Rate = 5%
Semiannual Coupon Rate = 2.50%
Semiannual Coupon = 2.50%*$1,000 = $25

Time to Maturity = 25 years
Semiannual Period to Maturity = 50

Let semiannual YTM be i%

$980 = $25 * PVIFA(i%, 50) + $1,000 * PVIF(i%, 50)

Using financial calculator:
N = 50
PV = -980
PMT = 25
FV = 1000

I = 2.57%

Semiannual YTM = 2.57%
Annual YTM = 2 * 2.57%
Annual YTM = 5.14%

Before-tax Cost of Debt = 5.14%
After-tax Cost of Debt = 5.14% * (1 - 0.35)
After-tax Cost of Debt = 3.341%

Preferred Stock:

Number of shares outstanding = 35,000
Current Price = $69
Annual Dividend = 3.50%*$100 = $3.50

Value of Preferred Stock = 35,000 * $69
Value of Preferred Stock = $2,415,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $3.50 / $69
Cost of Preferred Stock = 5.07%

Equity:

Number of shares outstanding = 525,000
Current Price = $58

Value of Common Stock = 525,000 * $58
Value of Common Stock = $30,450,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 3.5% + 0.98 * 8%
Cost of Common Equity = 11.34%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $11,760,000 + $2,415,000 + $30,450,000
Value of Firm = $44,625,000

Weight of Debt = $11,760,000/$44,625,000
Weight of Debt = 0.2635

Weight of Preferred Stock = $2,415,000/$44,625,000
Weight of Preferred Stock = 0.0541

Weight of Common Stock = $30,450,000/$44,625,000
Weight of Common Stock = 0.6824

WACC = Weight of Debt*After-tax Cost of Debt + Weight of Preferred Stock*Cost of Preferred Stock + Weight of Common Stock*Cost of Common Stock
WACC = 0.2635*3.341% + 0.0541*5.07% + 0.6824*11.34%
WACC = 8.89%