Question

Gimley enterprises, has a target capital structure of 35% long term debt, 10% prefered stock, and the balance common stock. Currently they have 14-year, 7.8% coupon (semianual) bond priced at $1,065. T-bills currently yiled 2.5%. The company is 40% more risky than the overall market, which is expected to earn 7.5% going forward. Gimleys prefered shares priced at $72, currently pay $4.35/share dividend. With a tax rate of 34%, what is Gimleys WACC.

Answer 1

Before tax cost of debt that is YTM of bond is calculated in excel and screen shot provided below:

Yield to maturity of bond is 7.06%

Tax rate = 34%

After tax cost of debt = 7.06% × (1 - 34%)

= 4.66%

After tax cost of debt is 4.66%.

Beta of company = 1.40

Cost of equity = 2.50% + (7.50% - 2.50%) × 1.40

= 2.50% + 7%

= 9.50%

Cost of equity is .50%.

Cost of preferred stock = $4.35 / $72

= 6.04%.

Cost of preferred stock is 6.04%

Now, WACC is calculated below:

WACC = (4.66% × 35%) + (6.04% × 10%) + (55% × 9.50%)

= 1.63% + 0.60% + 5.23%

= 7.46%

WACC of company is 7.46%.