Question

A company has a targeted capital structure of 50% debt and 50% equity. Bond (debt) with face value (or principal amount) of $1200.00 paid 12% coupon annually, mature in 20 years and sell for $950.90. The company’s stock beta is 1.4, the risk free rate is 9% and market risk premium is 6%. The company has a constant growth rate of 6% and a just paid dividend of $3 and sells at $32 per share. If the company’s marginal, tax rate is 35% calculate:

IV. What is the WACC using DDM?

V. If the flotation cost of new equity is 10%. What will be the company’s cost new equity capital?

VI. What would be the company’s WACC using the new capital?      

Answer 1

4) Using DDM, cost of equity, re = D0 x (1 + g) / P + g = 3 x (1 + 6%) / 32 + 6% = 15.94%

Cost of debt can be calculated using I/Y function

N = 20, PMT = 12% x 1200 = 144, PV = -950.90, FV = 1200 => Compute I/Y = 15.39% = rd

WACC = we x re + wd x rd x (1 - tax)

= 50% x 15.94% + 50% x 15.39% x (1 - 35%)

= 12.97%

5) Cost of new equity, rs = D0 x (1 + g) / P x (1 - f) + g = 3 x 1.06 / (32 x (1 - 10%)) + 6% = 17.04%

6) WACC = 50% x 17.04% + 50% x 15.39% x (1 - 35%) = 13.52%