Question

Sandoz Corporation is estimating its WACC. The company has 50,000 semi-annual bonds outstanding with a 7.5% coupon rate, $1,000 par value, 15 years to maturity, selling for 98.1 percent of par. Sandoz has 1 million common shares outstanding, currently selling for $50 per share with a beta of 1.08. In addition, there are 150,000 shares of 8% preferred stock outstanding, currently trading for $100 per share.

The risk-free rate is 3% and the market risk premium is 11%. The marginal tax rate is 35%. Sandoz expects to pay a common share dividend of $4.44 during the next year and plans to increase it at an annual rate of 6% for the foreseeable future.

Please solve A, B, and C. Please show work.

A. What is the firm's pre-tax cost of debt?

B. What is the firm’s after-tax cost of debt

C. What is the firm’s' cost of preferred stock

Answer 1

A:

pre-tax cost of debt is the YTM of the bond

YTM is the Internal rate of return of all the cashflows and can be calculated as below.

Coupon =7.5% of 1000 =75 ; coupon are given semi annualy=> 37.5 $ half years

n=15 years=30 half years ;current price=981

YTM is calculated as below

Bond (Annual payment)
Years	0	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	16	17	18	19	20	21	22	23	24	25	26	27	28	29	30
Price	981
Coupon payment		37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5
Par value																															1000
Total cashflows	-981	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	37.5	1037.5
IRR (=irr formula)	3.858%
YTM (IRR*2)	7.72%

cost of debt= YTM= 2*IRR =7.72% (since each cashflows are half year)

B:

After tax cost of debt= cost of debt*(1-tax rate) =7.72*(1-.35) =5.018%

C:

cost of preferred stock = preferred dividend/preferred share price = 8/100 =8%