Question

1. Given the following information on Ke-Ma-Gen Ltd., what is its WACC?              

Debt:

• Number of bonds = 10,000
• Par value = $1,000
• Coupon rate = 9% (semi-annual coupons)
• Time to maturity = 10 years
• Market value = 98% of par

Common equity:

• Number of shares outstanding = 1,000,000
• Par value = $1
• Price per share = $3.50
• Dividends per share = $0.70

Preferred equity:

• Number of shares outstanding = 50,000
• Price per share = $20
• Dividend yield = 5%

Other information:

• Tax rate = 40%
• Equity beta = 1.2
• Market risk premium = 16%
• Risk-free rate = 5%

Answer 1

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of equity * cost of equity)

market value of debt = 10,000 * $1,000 * 98% = $9,800,000

market value of preferred stock = 50,000 * $20 = $1,000,000

market value of equity = 1,000,000 * $3.5 = $3,500,000

total market value = $14,300,000

weight of debt = $9,800,000 / $14,300,000 = 0.685

weight of preferred stock = $1,000,000 / $14,300,000 = 0.070

weight of equity = $3,500,000 / $14,300,000 = 0.245

cost of debt = YTM of bond * (1 - tax rate)

YTM is calculated using RATE function in Excel with these inputs :

nper = 10*2 (10 years to maturity with 2 semiannual coupon payments each year)

pmt = 1000 * 9% / 2 (semiannual coupon payment = face value * annual coupon rate / 2. this is a positive figure as it is an inflow to the bondholder)

pv = -1000 * 98% (current bond price = face value *98%. this is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. this is a positive figure as it is an inflow to the bondholder)

the RATE is calculated to be 4.66%. This is the semiannual YTM. To calculate the annual YTM, we multiply by 2. Annual YTM is 9.31%

cost of debt = 9.31% * (1 - 40%) ==> 5.59%

cost of preferred stock = dividend yield = 5%

cost of equity (CAPM) = risk free rate + (beta * market risk premium)

cost of equity (CAPM) = 5% + (1.2 * 16%) ==> 24.20%

WACC = (0.685 * 5.59%) + (0.070 * 5%) + (0.245 * 24.2%) = 10.10%