Question

The charter company has the following financing outstanding. What is the WACC for the company?

Debt: 40,000 bonds with a 8% coupon rate and a current price quote of 1200 the bonds have 25 years to maturity. 150,000 zero coupon bonds with a price quote of 185 and 30 years to maturity.

Preferred Stock: 100,000 shares of 5% preferred stock with a current price of $78, and a par value of $100.

Common Stock: 1,800,000 shares of Common Stock; the current price is $75. And the beta of the stock is 1.2.

Market: The corporate tax rate is 40%, the market risk premium is 7%, and the risk free rate is 4%

Answer 1

Answer : Calculation of WACC :

Caculation of Cost of Debt (8% coupon bond)

Using Financial Calculator

=RATE(nper,pmt,pv,fv)

where nper is Number of years to maturity i.e 25

pmt is Interest payment i.e 1000 * 8% =80

pv is Current Market Price

= - 1200

Note : pv should be taken as negative.

fv is face value i.e 1000 (Assumed)

=RATE(25,80,-1200,1000)

therefore ,Before tax cost of Debt is 6.37872%

After tax cost of Debt = 6.37872% * (1 - Tax rate )

= 6.37872% * (1 - 0.40)

= 3.83%

Caculation of Cost of Debt (Zero coupon Bond)

Using Financial Calculator

=RATE(nper,pmt,pv,fv)

where nper is Number of years to maturity i.e 30

pmt is Interest payment i.e 0

pv is Current Market Price

= - 185

Note : pv should be taken as negative.

fv is face value i.e 1000 (Assumed)

=RATE(30,0,-185,1000)

therefore ,Before tax cost of Debt is 5.78586%

After tax cost of Debt = 5.78586% * (1 - Tax rate )

= 5.78586% * (1 - 0.40)

= 3.47%

Calculation of Cost of Equity

Cost of Common Equity = Risk free rate + (Beta * Market Risk premium)

= 4% + (1.2 * 7%)

=12.4%

Calculation of Cost of Preferred Stock

Cost of Preferred Stock = Annual Dividend / Current Market Price

= (100 * 5%) / 78

= 6.41025641%

Calculation of Weight of Equity and Debt of the firm :

Market Value of Equity = Number of Equity shares * Price per share

= 1,800,000 * 75

= 135,000,000

Market Value of Debt = Number of Bond Outstanding * Price per Bond

= 40,000 * 1200

= 48,000,000

Market Value of Zero Coupon Bond = Number of Bond Outstanding * Price per Bond

= 150,000 * 185

= 27,750,000

Market Value of Preferred Stock = Number of Preferred Stock * Price per share

= 100,000 * 78

= 7,800,000

Total Market Value = 135,000,000 + 48,000,000 + 27,750,000 + 7,800,000

= 218,550,000

Weight of Equity = Market Value of Equity / Total Market Value

= 135,000,000 / 218,550,000

= 0.61770761839 or 0.6177

Weight of Debt = Market Value of Debt / Total Market Value

= 48,000,000 / 218,550,000

= 0.21962937542 or 0.2196

Weight of Zero coupon Bond = Market Value of Zero Coupon Bond / Total Market Value

= 48,000,000 / 218,550,000

= 0.12697323266 or 0.1270

Weight of Preferred Stock = Market Value of Preferred Stock / Total Market Value

= 7,800,000 / 218,550,000

= 0.0356897735 or 0.0357

Calculation of WACC of the Firm

WACC = (Cost of After tax Debt * Weight of Debt) + (Cost of After tax Zero coupon Bond * Weight of Zero Coupon Bond) + (Cost of Preferred Stock * Weight of Preferred Stock) + ( Cost of Equity * Weight of Equity)

= (3.83% * 0.2196) + (3.47% * 0.1270) + (6.41025641% * 0.0357) + (12.4% * 0.6177)

= 0.841068% + 0.44069% + 0.2288% + 7.65948%

= 9.17%