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 D and E. Please show work.

D. What is firm’s cost of common stock?

E. What is the firm’s WACC?

Answer 1

D. Cost of common stock using CAPM model =risk free rate+(Beta*market risk premium)=3%+(1.08*11%)=3%+11.88%=14.88%

E. WACC=(weight of debt*after tax cost of debt)+(weight of preferred stock*cost of preferred stock)+(weight of equity*cost of equity)

First we have to find the before tax cost of debt using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

Here the bonds are semi-annual,

nper=total number of periods=2*15=30

pmt=semi-annual coupon payment=(coupon rate*face value)/2=(7.5%*1000)/2=75/2=37.5

pv=98.1%*1000=981

fv=1000

=RATE(30,37.5,-981,1000,0)

RATE=semi-annual yield=3.86%

Before tax cost of debt=annual yield=2*3.86%=7.72%

After tax cost of debt=Before tax cost of debt*(1-tax rate)=7.72%*(1-35%)=5.02%

Cost of preferred stock=8%

Market value of the debt=Total number of bonds*price of the bond=50,000*981=$49,050,000

Market value of equity=Outstanding shares*share price=1 million*50=$50,000,000

Market value of preferred stock=Outstanding shares*share price=150,000*100=$15,000,000

Total value=$49,050,000+$50,000,000+$15,000,000=$114,050,000

Weight of debt=Market value of debt/Total Value=$49,050,000/$114,050,000=43.0%

Weight of preferred stock=Market value of preferred stock/Total value=$15,000,000/$114,050,000=13.2%

Weight of equity=Market value of Equity/Total Value=$50,000,000/$114,050,000=43.8%

WACC=(43.0%*5.02%)+(13.2%*8%)+(43.8%*14.88%)=9.73%