Question

If your company has 30,000 bonds issued with 5 years to maturity with a quarterly payment of 18.00 and a selling price at 98% of par. It also has 100,000 shares of preferred stock at price of 100.00 paying a five percent dividend. The company has a common stock price of 12.50 per shares and 4,000,000 shares. The company’s beta is 1.35. The t-bill rate is 2.45% and the overall market rate is 8.5%. What is the Wacc if the tax rate is 35%? (Show work)

Answer 1

Cost of Equity

Cost of Equity Capital [as per CAPM] = Rf + Beta[Rm – Rf]

= 2.45% + 1.35[8.50% - 2.45%]

= 2.45% + 8.17%

= 10.62%

Cost of Preferred Stock = 5% [Given]

Cost of Debt

Yield To Maturity [YTM] = Coupon Amount + [(Face Value – Bond Price) / Maturity Years] / [(Face Value + Bond Price)/2]

= $72 + [($1,000 - $980) / 5)] / [($1,000 + $980) / 2]

= [($72 + 4 ) / $990] x 100

= 7.70%

After Tax Cost of Debt = 7.70% x [ 1 – Tax Rate]

= 7.70% x [1 – 0.35]

= 5%

Weights

Market Value of Equity = 40,00,000 Shares x $12.50 = $5,00,00,000

Market Value of Preferred Stock = 100,000 Shares x $100 = $1,00,00,000

Market Value of Debt = 3,000 x $1,000 x 98% = $2,94,00,000

Total market Value = $8,94,00,000

Weight of Equity = $5,00,00,000 / $ 8,94,00,000 = 0.5593

Weight of Preferred = $1,00,00,000 / $ 8,94,00,000 = 0.1119

Weight of Debt = $2,94,00,000 / $8,94,00,000 = 0.3289

Weighted Average Cost of Capital [WACC]

= [Cost of equity x Weight of Equity] + [Cost of Preferred stock x Weight of preferred stock] + [After Tax Cost of Debt x Weight of Debt]

= [10.62% x 0.5593] + [5% x 0.1119] + [5% x 0.3289]

= 5.94% + 0.56% + 1.64%

= 8.14%