Question

Caspian Sea Drinks' is financed with 61.00% equity and the remainder in debt. They have 11.00-year, semi-annual pay, 5.40% coupon bonds which sell for 97.87% of par. Their stock currently has a market value of $24.17 and Mr. Bensen believes the market estimates that dividends will grow at 3.21% forever. Next year’s dividend is projected to be $2.69. 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 = 1-0.39

W(E)=0.61

Weight of debt = D/A

Weight of debt = 0.39

W(D)=0.39

Cost of equity

As per DDM

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

24.17 = 2.69/ (Cost of equity - 0.0321)

Cost of equity% = 14.34

Cost of debt

K = Nx2

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

k=1

K =11x2

978.7 =∑ [(5.4*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^11x2

k=1

YTM = 5.662809524

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

After tax cost of debt = 5.662809524*(1-0.24)

= 4.30373523824

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

WACC=4.3*0.39+14.34*0.61

WACC =10.42%