Question

The Centurion Corp. has 3 million shares of common stock with a current market price of $76.00 per share. The most recent dividend paid (i.e., D₀) on these shares was $2.90. The growth rate for Centurion has been 7.2% in the past and is expected to continue in the future. Centurion has a beta of 1.3, the risk-free rate is 3.6%, and the return on the market is 10.1%

Assume Centurion has $130 million in par value of long-term bonds outstanding that currently sell for $1,091.96 per $1,000 par value. The bonds have a coupon rate of 8% and a maturity of 15 years. Assume semi-annual coupon payments

Now assume Centurion has 500,000 shares of preferred stock with a current market price of $109 per share. The annual dividend on this preferred stock is $9.20 per share.

calculate Centurion’s weighted average cost of capital using all of the information in the previous three questions to calculate market value weights. You may assume that they use the average of the CAPM and constant growth models (without flotation costs) for the cost of common equity

Answer 1

I AM ASSUMING THE TAX RATE IS 25%. IF QUESTION HAS A DIFFERENT TAX RATE, PLEASE PUT IN COMMENTS AND I WILL RE DO THE QUESTION.

Cost of equity using dividend discount = (D1 / price) + growth rate

Cost of equity using dividend discount = [(2.9 * 1.072) / 76] + 0.072

Cost of equity using dividend discount = 0.040905 + 0.072

Cost of equity using dividend discount = 0.11291 or 11.291%

Cost of equity using CAPM = Risk free rate + beta (return on market - risk free rate)

Cost of equity using CAPM = 3.6% + 1.3 (0.101 - 0.036)

Cost of equity using CAPM = 0.1205 or 12.05%

Average cost of equity = (11.291% + 12.05%) / 2

Average cost of equity = 11.6705%

Coupon = (0.08 * 1000) / 2 = 40

Number of periods = 15 * 2 = 30

Cost of debt before debt = 7%

Keys to use in a financial calculator: 2nd I/Y 2, FV 1000, PV -1091.96, N 30, PMT 40, CPT I/Y

cost of preferred equity = (Dividend / price) * 100

cost of preferred equity = (9.2 / 109) * 100

cost of preferred equity = 8.44%

Market value of common stock = 3,000,000 * 76 = 228,000,000

Market value of preferred stock = 500,000 * 109 = 54,500,000

Number of bonds = 130,000,000 / 1,000 = 130,000

Market value of bonds = 130,000 * 1,091.96 = 141,954,800

Total market value = 228,000,000 + 54,500,000 + 141,954,800 = 424,454,800

weighted average cost of capital = Weight of debt*after tax cost of debt + weight of equity*cost of equity + weight of preferred stock*cost of preferred stock

weighted average cost of capital = (141,954,800 / 424,454,800)*0.07*(1 - 0.25) + (228,000,000 / 424,454,800)*0.116705 + (54,500,000 / 424,454,800)*0.0844

weighted average cost of capital = 0.017558 + 0.062689 + 0.010837

weighted average cost of capital = 0.0911 or 9.11%

Also WACC without tax as there is no tax in question

weighted average cost of capital = Weight of debt*after tax cost of debt + weight of equity*cost of equity + weight of preferred stock*cost of preferred stock

weighted average cost of capital = (141,954,800 / 424,454,800)*0.07 + (228,000,000 / 424,454,800)*0.116705 + (54,500,000 / 424,454,800)*0.0844

weighted average cost of capital = 0.023411 + 0.062689 + 0.010837

weighted average cost of capital = 0.0970 or 9.70%