Question

The Bluefield Corporation has 6 million shares of common stock outstanding, 600,000 shares of preferred stock that pays an annual dividend of $8.00, and 200,000 - $1000 par value bonds with a 10% coupon. The bonds pay interest semi-annually, and have 20 years to maturity.

At present, the common stock is selling for $50 per share, the bonds for $950.62 each, and the preferred stock at $74 per share. The estimated required rate of return on the market is 13%, the risk free rate is 8%. Bluefield has a beta of 1.4 and a tax rate of 30%. Estimate the cost of each source of financing, the weights to apply to each source, and the WACC. Then match each item with the appropriate answer.

-Rate of Equity

-Rate of Debt (After tax)

-Rate of Preferred stock

-Weight of Equity

-Weight of Debt

-Weight of Preferred stock

-Weighted Average Cost of Capital

Please show calculation steps so I can understand how to solve.

Thank you!

Answer 1

Using CAPM, Rate of equity, rs = Rf + beta x (Rm - Rf) = 8% + 1.4 x (13% - 8%) = 15.0%

Before-tax rate of debt is the YTM of the bonds, which can be calculated using I/Y function on a calculator

N = 20 x 2 = 40, PMT = 10% x 1000 / 2 = 50, PV = -950.62, FV = 1000 => Compute I/Y = 5.30% (semi-annual)

Annualized after tax cost of debt = 5.30% x 2 x (1 - 30%) = 7.42%

Rate of preferred = Dividend / Price = 8 / 74 = 10.81%

	Value	Weight	Rate
Equity	300.00	56.12%	15.00%
Debt	190.12	35.57%	7.42%
Preferred	44.40	8.31%	10.81%
Total	534.52	WACC	11.96%

Value = Unit x Price

Weight = Value / Total

WACC = Sum product of weights and rates = 56.12% x 15% + 35.57% x 7.42% + 8.31% x 10.81% = 11.96%