Question

A company has 14 million shares of common stock outstanding with a beta of 1.15 and a market price of $45 a share. There are 1,000,000 shares of 9 percent preferred stock outstanding valued at $80 a share. The 10 percent semiannual coupon bonds have a face value of $1,000 and are selling at 92 percent of par. There are 280,000 bonds outstanding that mature in 15 years. The market risk premium is 12 percent, T-bills are yielding 4.5 percent, and the firm’s tax rate is 21 percent. Compute the weighted average cost of capital of the company.

Answer 1

14 millions Common stock outstanding

Beta = 1.15

MRP (Rm-Rf) = 12%

Rf = 4.5%

Market price = $45

Calculation of Required rate of return using CAPM = R_f + β(R_m - R_f)

= 4.5+ 1.15*12

= 4.5+13.8

= 18.3%

Market value of common stock = $45*14 million = $630 million

9% Preference shares = 1 million @ $80

Cost of preference shares = Dividend on preference shares/Net proceeds from issue of preference share

= 100*9%/80

= 9/80

= 11.25%

Market value of preference shares = $80*1 million

= $80 million

10% semiannual coupon bonds F.V. = $1000

Tax = 21%

No. of bonds = 280,000

Selling @ $920

Maturity = 15 years

Yield – to – Maturity of the Bond (YTM)

YTM = {C+(F - P)/n} / {(F + P)/2}

= {100(1-0.21) + (1000–920)/15} / {1000+920/2}

= (79+5.33)/960

= 8.78%

Market value of Bonds = $920*280,000

= $257.60 million

Total market value of Company = ($630+$80+$257.60) millions

= $967.60 millions

WACC of the Company = weighted average of cost of capital of Common stock, preference stock and debts

= 18.3%*$630+11.25%*$80+8.78%*$257.60/$967.60

= 15.38%