Question

A firm is considering a new project that will require an initial outlay of $20 million. It has a target capital structure of 55% debt, 15% preferred stock, and 30% common equity.  The firm has non-callable bonds that mature in five years with a face value of $1,000, an annual coupon rate of 8%, and a market price of $1080.64.  The yield on the company’s current bonds is a good approximation of the yield on any new bonds that are issued.  The cost of preferred stock for the firm is 12.5% and the cost of common equity is 14%.  The firm has a marginal tax rate of 40%. Determine the firm’s WACC for this project

Answer 1

The Approximate Yield to Maturity Formula =[Coupon + ( Face Value - Market Price) / Number of years to maturity] / [( Face Value + Market Price)/2 ] *100

Since this formula gives an approximate value, the financial calculators can be used alternatively.

where,

Par Value = $ 1,000

Market Price = $  1080.64

Annual rate = 8% and

Maturity in Years = 5 Years

Hence the yield to maturity =6.08 %

Now, the after tax cost of debt = Yield to Maturity * (1- tax Rate)

= 6.08% * ( 1-40%)

= 3.648%

WACC = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)+ (Cost of Preferred Stock * Weight of Preferred Stock )

= 8.08%

	Cost	Weight	Cost * Weight
Debt	3.65%	55%	2.01
Equity	14%	30%	4.20
Preferred Stock	12.50%	15%	1.88
Total			8.08

Answer = 8.08%