Question

8.4 Chapter 8 HW - Problem Mastery

7) LUVFINANCE, Inc. is estimating its WACC. It is operating at its optimal capital structure. Its outstanding bonds have a 12 percent coupon, paid semiannually, a current maturity of 17 years, and sell for $1,162.   It has 100,000 bonds outstanding. The firm can issue new 20-year maturity semiannual bonds at par but will incur flotation costs of $50 per bond (Hint: the coupon rate on the new bonds = the YTM on existing bonds). The firm could sell, at par, $100 preferred stock that pays a 12 percent annual dividend that is currently selling for $120. The firm currently has 1,000,000 shares of preferred stock outstanding. Rollins' beta is 1.53, the risk-free rate is 2.64 percent, and the market risk premium is 6 percent.   The common stock currently sells for $100 a share and there are 5,000,000 shares outstanding. The firm's marginal tax rate is 40 percent.   What is the WACC?

9) Lipscomb Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for 1,000 USD. The firm could sell, at par, 100 USD preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Libscomb is a constant-growth firm which just paid a dividend of $2.00, sells for 27.00 USD per share, and has a growth rate of 8 percent. The firm's marginal tax rate is 40 percent.

Answer 1

7

MV of equity=Price of equity*number of shares outstanding

MV of equity=100*5000000

=500000000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*100000*1.162

=116200000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=120*1000000

=120000000

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=500000000+116200000+120000000

=736200000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 500000000/736200000

W(E)=0.6792

Weight of debt = MV of Bond/MV of firm

Weight of debt = 116200000/736200000

W(D)=0.1578

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 120000000/736200000

W(PE)=0.163

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 2.64 + 1.53 * (6)

Cost of equity% = 11.82

Cost of debt

K = Nx2

Bond Price -flotation cost =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =20x2

1162-50 =∑ [(12*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^20x2

k=1

YTM = 10.6371449019

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 10.6371449019*(1-0.4)

= 6.38228694114

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 12/(120)*100

=10

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=6.38*0.1578+11.82*0.6792+10*0.163

WACC =10.66%