Question

At 2018 ABI Construction has a face debt value of 22.48M trading at 96% with a pre-tax weigthed cost of 4.04%. ABI common equity for the year was valued at 115.84M and preferred equity for 13.63M. The Preferred equity rate was calculated to be 7%. However, the common equity was to be calculated using CAPM approach, with a 3% risk free rate and a 7% market risk premium rate, assuming a 1.65 Beta. If the tax rate is 42%, What is this firm’s WACC?

Answer 1

- Market Value of debt = Face value of debt*Trading Price

= $22.48M*96%

= $21.5808M

- Market Value of equity = $115.84M

- Market Value of Preferred Equity = $13.63M

Total Capital Structure = Market Value of Debt + Market Value of equity + Market Value of preferred equity

Total Capital Structure = $21.5808M + $115.84M+ $13.63M

Total Capital Structure = $151.0508M

- Before-Tax cost of debt = 4.04%

- Cost of Preferred Equity = 7%

As per CAPM Method,

where, rf = Risk free return = 3%

Rmp = Market Risk Premium = 7%

Beta = 1.65

Required rate of Return = 3% + 1.65(7%)

Required rate of Return = 14.55%

So, Cost of equity = 14.55%

calculating WACC of firm:-

WACC= (Weight of Debt)(Before-tax Cost of Debt)(1-Tax rate) + (Weight of Common stock)(Cost of Retained earnings) +(Weight of Preferred Stock)(Cost of Preferred Stock)

WACC = (21.5808M/151.0508M)(4.04%)(1-0.42) + (115.84M/151.0508M)(14.55%) + (13.63M/151.0508M)(7%)

WACC = 0.3348% + 11.1583% + 0.6316%

Firm's WACC = 12.12%