Question

Please answer it correctly. Here is a short problems. Please solve all problems correctly. Make sure the answers are correct. I would really appreciate your effort. Thanks.

1). The Oriole Products Co. currently has debt with a market value of $275 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,429.26 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $14 per share. The preferred shares pay an annual dividend of $1.20. Oriole also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 4 percent per year forever. If Oriole is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?

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Calculate the weights for debt, common equity, and preferred equity. (Round intermediate calculations and final answers to 4 decimal places, e.g. 1.2514.)

Debt _________?

Preferred Equity ________?

Common Equity ________?

Calculate the cost of debt. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Cost of debt _______%

Calculate the cost of preferred equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Cost of preferred equity _________%

Calculate the cost of common equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 0 decimal places, e.g. 15%.)

Cost of common equity_________%

What is the firm’s weighted average cost of capital? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

WACC______%

Answer 1

Debt: Market Value = $ 275 million, Debt Bond Coupon = 9 %, Coupon Frequency: Semi-Annual, Bond Maturity = 15 years, Current Bond Price = $ 1429.26 and Par Value of Bonds = $ 1000 (assumed)

Semi-Annual Bond Coupon = 0.09 x 1000 x 0.5 = $ 45

Let the yield to maturity be 2Y

Therefore, 1429.26 = 45 x (1/Y) x [1-{1/(1+Y)^(30)}] + 1000 / (1+Y)^(30)

Using EXCEL's Goal Seek Function/hit and trial method/ a financial calculator to solve the above equation, we get:

Y = 0.0246 or 2.46%

Cost of Debt = kd = 2 x Y = 2 x 2.46 = 4.92 %

Preferred Equity: Number of Preferred Stock = 2 million, Market Price = $ 14 and Annual Dividend = $ 1.2

Market Value of preferred Equity = 2 x 14 = $ 28 million

Cost of Preferred Equity = kp = 1.2 / 14 = 0.0857 or 8.57 %

Common Equity: Number of Common Stock = 14 million, Market Price = $ 20, Expected Dividend = $ 2.2 and Dividend Growth Rate = 4 %

Market Value of Common Equity = 20 x 14 = $ 280 million

Cost of Common Equity = ke = (2.2/20) + 0.04 = 0.15 or 15%

Total Firm Value = 275 + 28 + 280 = $ 583 million

Debt Weight = (275/583) = 0.471698 or 47.1698 %

Preferred Equity Weight = (28/583) = 0.048028 or 4.8028 %

Common Equity Weight = (280/583) = 0.480274 or 48.0274%

Tax Rate = 40 %

Weighted Average Cost of Capital = (1-Tax Rate) x kd x Debt Weight + ke x Common Equity Weight + kp x Preferred Equity Weight = (1-0.4) x 4.92 x 0.471698 + 15 x 0.480274 + 8.57 x 0.048028 = 9.00816 % ~ 9.01 %