Question

He also wants to know the WACC and has given you the following information about your capital budgeting:

The 20 year $1000 par value mortgage bonds were sold at $952.67 and pay 8%. They had a $47.67 flotation cost.

What is the cost of the mortgage bonds?

Answer:

The 15 year $500 par value debentures were sold at $486.50 and pay 6%. They had a $26.50 flotation cost.

What is the cost of the debentures?

Answer:

DWOTT paid a dividend of $.80 last year and expects them to grow 15% next year and into the foreseeable future. The stock currently trades at $36.70.

What is the cost of retained earnings?

Answer:

What is the weighted average cost of capital?

Answer:

Answer 1

	YTM = [Annual interest +(Face value-market price)/n]/(Face value +2*market price)/3
	Here Par value of Bond=1000
	Market Price =952.67
	Floatation cost =47.67
	Net Market Price=952.67-47.67=905
	n=20 years
	Annual interest =1000*8%=80
	YTM= [80+(1000-905)/20]/(1000+905*2)/3
	or YTM =9.05%
	So cost of Mortgage bond=9.05%
	Debenture cost
	Par value =500
	Sales Price =486.5
	Floating cost =26.5
	Met Market Price =486.5-26.5=460
	n=15 years
	Annual interest @6%=30
	YTM =[30+(500-460)/15]/(500+2*460)/3
	YTM =6.90%
	So cost of Debenture =6.9%
	Equity Valuation Model
	P0=d0(1+g)/Ke-g
	Here P0= current stock value=36.7
	d0=current dividend=0.8
	g=15%
	Ke=cost of equity
	So, 36.7=0.80*1.15/(ke-0.15)
	ke-0.15=0.251
	ke= 0.1751
	So Cost of Retained earning =17.51%
	WACC	a	b	c	=b*c
	Capital Type	Market Price	Weight	Cost of Capital;	Weighted cost
	Mortgage Bond	905	65%	9.05%	5.84%
	Debenture	460	33%	6.90%	2.26%
	Equity	36.7	3%	17.51%	0.46%
		1401.7	100%		8.57%
	So WACC is 8.57%