Question

Kuhn Co. is considering a new project that will require an initial investment of $4 million. It has a target capital structure of 35% debt, 2% preferred stock, and 63% common equity. Kuhn has noncallable bonds outstanding that mature in five years with a par value of $1,000, an annual coupon rate of 10%, and a market price of $1,050.76. The yield on the company's current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividend of $8 at a price of $92.25 per share. Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $22.35 per share, and is expected to pay a dividend of $2.78 at the end of next year. Floatation costs will represent 3% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 40%. What is the Kuhn Company's WACC for this project?

Answer 1

Weight of equity (W_e) = 63%,Weight of debt (W_d) = 35%, Weight of preferred stock (W_p) = 2%
Cost of preferred stock = Dividend / price per share = 8/ 92.25 = 8.672%
Cost of Debt (YTM)
coupon = Coupon rate * face value = 10% * 1000 =100
Price of Bond = Coupon_t/(1+YTM)^t + Face Value/(1+YTM)^t =   100/(1+YTM)^t + 1000/(1+YTM)^t
1050.76 = 100/(1+YTM)^t + 1000/(1+YTM)t
YTM = 8.705%

For Cost of equity
Cost of Equity = [Dividend paid next year/(P(1-Floation cost)] + growth
[ 2.78 /22.35 * ( 1- 3%)] + 9.2% = 2.78/21.6795 + 0.092 = 22.023%

WACC = W_e * Cost of Equity + W_d * Cost of debt *(1 - tax rate) + W_p * Cost of Portfolio = 0.63 * 22.2023% + 0.35 * 8..705% *( 1-40%) + 0.02 * 8.672% = 15.875% or 15.88%

Best of Luck. God Bless

Best of Luck. God Bless