Question

ABC Ltd currently has $300 million of market value debt outstanding. The 9 per cent coupon bonds (semiannual payment) have a maturity of 15 years and are currently priced at $1,440.03 per bond. The company also has an issue of 2 million preference shares outstanding with a market price of $12.00. The preference shares offer an annual dividend of $1.20. ABC also has 14 million ordinary shares outstanding with a price of $20.00 per share. The company is expected to pay a $2.20 ordinary dividend one year from today, and that dividend is expected to increase by 5 per cent per year forever.corporate tax rate is 30 per cent

Calculate the company's WACC

Answer 1

WACC = Cost of Preferred Equity * Weight of Preferred Equity + Cost of Common Equity * Weight of Common Equity + Cost of Debt * (1 - Tax rate) * Weight of Debt

Cost of Preferred Equity = Annual dividend/Market price = $1.20/$12 = 10%

Market Value of Preferred Equity = 2 mil * $12 = $24 mil

Cost for common equity can be calculated using dividend discount model. Price of Share today = D₁/(r - g)

where g is the growth of dividend

20 = $2.20/(r - 5%)

Cost of Common Equity, r = 16%

Market value of common stock = 14 mil * $20 = $280 mil

Market Value of Debt = $300 mil

We need to calculate YTM of the bond issue, to find cost of debt. Manually YTM calculation is possible only through approximation formula:

F = $1000, P = $1,440.03, C = 9% * $1000/2 = $45, n = 15 years --> 30 semi-annual periods.Substituting these values in formula above:

Approx YTM = 2.49% --> semi-annual

Hence, Annual YTM = 2 * 2.49% = 4.98%

Exact calculations in YTM are shown in Excel snapshot:

Weight of debt = 300/(280 + 24 + 300) = 49.67%

Weight of common stock = 280/(280 + 24 + 300) = 46.36%

Weight of preferred stock = 24/(280 + 24 + 300) = 3.97%

WACC = [4.84% * (1 - 30%) * 49.67%] + [10% * 3.97%] + [16% * 46.36%] = 9.50%