Question

GMC wants to raise an additional of debt as part of the capital that would be needed to expand their project operations.

1. They were informed by their investment banking consultant that they would have to pay a commission of 2% of the selling price on new issues. Their CFO is in the process of estimating the corporation’s cost of debt for inclusion into the WACC equation. The company currently has an 9%, AA-rated, non-callable bond issue outstanding, which pays interest semi-annually, will mature in 20 years, has a $1000 face value, and is currently trading at $1,058.

Calculate the appropriate cost of new debt for the firm.

2. GMC common stock is trading at $55.8 and its dividends are expected to grow at a constant rate of 6%. The company paid a dividend last year of $2.2. If the company issues stock they will have to pay a flotation cost per share equal to 5.5% of selling price. Calculate EMC's cost of equity with flotation costs.
3. GMC will also be issuing new preferred stock. They will pay a dividend of $4 per share which has a market price of $48. The flotation cost on preferred will amount to $2 per share. What is their cost of preferred stock?
4. The Market wight of equity is 50%, debt is 35% and preferred stock is 15% whereas the tax rate is 25% please calculate adjusted WACC for GMC.  

Answer 1

a. cost of debt for the firm is yield to maturity of the bond. we can use financial calculator for yield to maturity calculation.

interest is paid semi-annually. so maturity, interest payment and calculated yield to maturity will be semi-annual. we need to make semi-annual yield to maturity to annual by multiplying it by 2. also 2% commission needs to be paid on selling price. so current price of the bond will be 98%.

N = semi-annual maturity = 20*2 = 40; PMT = coupon payment = $1,000*9%/2 = 45; PV = current price = -$1,058*98% = -$1,036.84; FV = face value = $1,000 > CPT = compute > I/Y = semi-annual yield to maturity = 4.31%

PV needs to be entered as negative value because it's a cash outflow.

Cost of new debt = 4.31%*2 = 8.62‬%

b. cost of equity with flotation costs = [last year's dividend*(1+constant dividend growth rate)/(current price*(1-flotation cost)] + constant dividend growth rate

cost of equity with flotation costs = [$2.2*(1+0.06)/($55.8*(1-0.055)] + 0.06 = [($2.2*1.06)/($55.8*0.945)] + 0.06 = ($2.332‬/$52.731) + 0.06 = 0.0442 + 0.06 = 0.1042 or 10.42%

c. cost of preferred stock = annual dividend/(current price - flotation cost) = $4/($48 - $2) = $4/$46 = 0.0833 or 8.33%

d. WACC = weight of debt*after-tax cost of debt + weight of Preferred stock*cost of Preferred stock + weight of common stock*cost of common stock

after-tax cost of debt = cost of debt*(1-tax rate) = 8.62%*(1-0.25) = 8.62%*0.75 = 6.465‬%

WACC = 0.35*6.465% + 0.15*8.33% + 0.50*10.42% = 2.26275‬% + 1.2495‬% + 5.21‬% = 8.72%

adjusted WACC for GMC is 8.72%.