Question

Caspian Sea Drinks' is financed with 70.00% equity and the remainder in debt. They have 10.00-year, semi-annual pay, 5.93% coupon bonds which sell for 97.73% of par. Their stock currently has a market value of $25.66 and Mr. Bensen believes the market estimates that dividends will grow at 3.83% forever. Next year’s dividend is projected to be $2.75. Assuming a marginal tax rate of 24.00%, what is their WACC (weighted average cost of capital)?

Answer 1

Weight of equity = 1-D/A

Weight of equity = 1-0.3

W(E)=0.7

Weight of debt = D/A

Weight of debt = 0.3

W(D)=0.3

Cost of equity

As per DDM

Price= Dividend in 1 year/(cost of equity - growth rate)

25.66 = 2.75/ (Cost of equity - 0.0383)

Cost of equity% = 14.55

Cost of debt

K = Nx2

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

k=1

K =10x2

977.3 =∑ [(5.93*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^10x2

k=1

YTM = 6.2385341581

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

After tax cost of debt = 6.2385341581*(1-0.24)

= 4.741285960156

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

WACC=4.74*0.3+14.55*0.7

WACC =11.61%