Question

1. Calculate the WACC for the following company. The company has a capital structure that consists of 50% debt and 50% common stock the company’s CFO has obtained the following information:
   1. The yield to maturity on the company’s bonds is 7%
   2. The coupon rate on the company’s bonds is 5%
   3. The next expected dividend is expected to be $7.00
   4. The dividend is expected to grow at a constant rate of 5% per year
   5. The stock price is currently $75 per share
   6. The tax rate is 35%

What is the WACC?

2. Calculate the WACC for the following company: Jelly Inc.’s target capital structure is 40% debt, 10% preferred stock, and 50% common stock.
   1. The company’s 15-year, 7% coupon, 1000 par bonds are selling for $980
   2. The risk-free rate is 5%
   3. The expected return on the market is 10%
   4. Jelly ‘s beta is 1.2
   5. The company’s tax rate is 30%
   6. Preferred stock price is $90, and the preferred dividend is $9

What is Jelly’s WACC?

     3.  A company just paid a $2.00 per share dividend on its common stock. The dividend is expected to grow at a constant rate of 7 percent per year. The stock currently sells for $42 a share. What is the cost of equity?

Answer should be one decimal point. So, if the answer is 8.12%, enter 8.1.

    4. Outdoor Enterprises has bonds outstanding that carry an annual coupon of 10 percent. The bonds mature in 15 years and are currently priced at $1,050. The par value of the bond is $1,000. What is the firm's pre-tax cost of debt?

     5. Advanced Products has outstanding bonds that are currently priced at $980. The bonds mature in 12 years and carry an 8% annual coupon. The tax rate is 40%. What is the firm’s after-tax cost of debt?

Answer 1

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

where, wd - weight of debt = 50%, we - weight of equity = 50%, rd - cost of debt = 7%, tax = 35%, re - cost of equity = D1 / P + g = 7/75 + 5% = 14.33%

WACC = 50% x 7% x (1 - 35%) + 50% x 14.33% = 9.44%

2) Cost of debt can be calculated using I/Y function on a calculator

N = 15, PMT = 70, PV = -980, FV = 1000 => Compute I/Y = 7.22% = rd

Cost of preferred, rp = Dividend / Price = 9 / 90 = 10%

Cost of equity, re = Rf + beta x (Rm - Rf) = 5% + 1.2 x (10% - 5%) = 11.0%

=> WACC = 40% x 7.22% x (1 - 30%) + 10% x 10% + 50% x 11% = 8.52%

3) Cost of equity = D0 x (1 + g) / P + g = 2 x 1.07 / 42 + 7% = 12.10%

4) Cost of debt can be calculated using I/Y function on a calculator

N = 15, PMT = 100, PV = -1050, FV = 1000 => Compute I/Y = 9.37% is pre-tax cost of debt

5) N = 12, PMT = 80, PV = -980, FV = 1000 => Compute I/Y = 8.27% is pre-tax cost of debt

=> After-tax cost of debt = 8.27% x (1 - 40%) = 4.96%