Question

medicom co. has 6,500 bonds outstanding that are selling at 96.5% of par, paying semiannual coupon of 4.8% with 2 years remaining to maturity. the company also have 48,000 shares of 5.5% preferred stock at 75,000 shares of common stock outstanding .the preferred stock sells for $64 a share. the common stock has a beta of 1.32 and sells for $41 a share.the preferred stock has a stated value of $100. the risk free rate is 2.2% and the market risk premium is 8.4%. the corporate tax rate is 21 percent. a. what is the weighted average cost of capital ?

Answer 1

1). Cost of debt: Current price = 96.5%*par value = 96.5%*1,000 = 965

Semi-annual coupon = (4.8%/2)*par value = 24

Number of payments to be made = 2*2 = 4

YTM calculation: PV = 965; FV = 1,000; PMT = 24; N = 4, CPT RATE. Rate (or semi-annual YTM) = 3.35%

Annual YTM = 3.35%*2 = 6.70%

After-tax cost of debt (kd) = (1-Tax rate)*YTM = (1-21%)*6.70% = 5.29%

2). Cost of preferred shares:

Share price = 64; par value = 100; dividend yield = 5.5%; dividend = yield*par value = 5.5%*100 = 5.50

Cost of preferred (kp) = annual dividend/current price = 5.50/64 = 8.59%

3). Cost of common equity:

Using CAPM, cost of equity (ke) = risk-free rate + (beta*market risk premium)

= 2.2% + (1.32*8.4%) = 13.29%

4). Weights:

Debt amount = number of bonds*bond price = 6,500*965 = 6,272,500

Preferred amount = number of shares*share price = 48,000*64 = 3,072,000

Common equity amount = number of shares*share price = 75,000*41 = 3,075,000

Total = 6,272,500 + 3,072,000 + 3,075,000 = 12,419,500

Weight of debt (wd) = debt amount/total = 6,272,500/12,419,500 =50.51%

Weight of preferred (wp) = preferred amount/total = 3,072,000/12,419,500 = 24.74%

Weight of common equity (we) = equity amount/total = 3,075,000/12,419,500 = 24.76%

5). WACC calculation:

WACC = (wd*kd) + (wp*kp) + (we*ke)

= (50.51%*5.29%) + (24.74%*8.59%) + (24.76%*13.29%) = 8.09%