Question

In: Finance

The following information is given about your company. The company needs raise new capital to expand...

The following information is given about your company. The company needs raise new capital to expand its facilities. The company’s optimum capital structure has been 40% debt, 10% preferred stock and 50% equity. The company will maintain this capital structure in financing this expansion plan. Currently the company's common stock is traded at a price of $15.65 per share. The last dividend paid on the common stock was $1.25 per share. The company will grow at 6% constant rate for long time in the future. The company's preferred stock is selling at $85 and has a quarterly preferred dividend of $1.35. Flotation costs have been estimated at 8% on the common stocks and 5% on the preferred stocks. The company has some bonds with $1000 par value outstanding, the market price of the bonds is $1025, and the bonds have 14 years to maturity. The coupon rate on those bonds is 8% with semi-annual payments. The tax rate is 40%.

What is the WACC for this company if they will issue new common stocks and new preferred stocks?

Solutions

Expert Solution

WACC= Kd * Wd + Ke* We + Kp* Wp

Cost of common stock (Ke) = (D1/NP)+g

Here D1= D0*(1+g)

D1= 1.25 * (1+0.06)

D1= 1.325

NP= net proceeds = P-FC

NP= 15.65 - (15.65*0.08)

NP= 15.65 - 1.252

NP= 14.398

g= 6% given in question

Putting this in equation Ke = (D1/NP)+g

Ke = (1.325/14.398)+0.06

Ke= 0.15203 = 15.203%

Cost of preferred stock (Kp) = D/NP

D= 1.35 quarterly = 5.4 yearly (Hint: 1.35*4 = 5.4)

NP = P* (1-FC%)

NP= 85*(1-0.05)

NP= 80.75

Putting the values in the formula (Kp) = D/NP

Kp = 5.4/80.75

Kp = 0.06687 = 6.687%

Cost of Debt(Kd) = I%(1-T%)

For I% which is the yield of the bond, we need to use either the financial calculator of excel

use the function RATE in Excel and put FV=1000, PV = -1025, nper=14, PMT= 8%*1000= 80

The yield (I%)= 7.70%

Tax rate (T%)= 40%

Putting the values in equation (Kd) = I%(1-T%)

= 7.70%(1-40%)

Kd =4.6%

As given in the question the weight of capital are as follows

Weight of equity (We) = 50%

Weight of Preferred shares (Wp) = 10%

Weight of Debt (Wd) = 40%

and as we calculated

Ke= 15.203%

Kp = 6.687%

Kd =4.6%

Putting these values in the equation WACC= Kd * Wd + Ke* We + Kp* Wp

= 4.6%* 40% + 15.203%* 50% + 6.687%*10%

= 1.85% + 7.60% + 0.67%

WACC = 10.12%

jeff jeffy answered 6 months ago
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