Question

Question 26

Your firm has an expected stock return of 10%, an expected return on its preferred stock of 4%, and the yield on its bonds of 2%. The market value of common stock outstanding is $20 million, preferred stock is $2 million, and the market value of the firm's bonds is $3 million. The tax rate is 25%. What is the WACC?

Question 27

A share of preferred stock with an annual dividend of $5 has an expected return of 4.5% annually. What is the current estimated price of the preferred stock?

Question 28

Hoth Corporation's bonds carry a 1% coupon rate, pay coupons semiannually, and mature in 15 years. Similar bonds have a yield of 2%. What is the CURRENT YIELD for Hoth Corporation's bonds ?

Answer 1

Question 26

Total firm value= $20 million + $2 million +$3 million= $25 million.

weight of debt in the capital structure= $3 million/ $25 million

= 0.12*100= 12%

Weight of preferred stock= $2 million/ $25 million

= 0.08*100= 8%

Weight of common stock= $20 million/ $25 million

= 0.80*100= 80%

The weighted average cost of capital is calculated using the below formula:

WACC=Wd*Kd(1-t)+Wps*Kps+We*Ke

where:

Wd= Percentage of debt in the capital structure.

Kd= The before tax cost of debt

Wps= Percentage of preferred stock in the capital structure

Kps=Cost of preferred stock

We=Percentage of equity in the capital structure

Ke= The cost of common equity.

T= Tax rate

WACC= 0.12*2%*(1 - 0.25) + 0.08*4% + 0.80*10%

= 0.18 + 0.32 + 8

= 8.50%.

Question 27

Cost of preferred stock is calcualted using the below formula:

Kps=Dps/P

where:

Kps=Cost of preferred stock

Dps=preferred dividend

P= Market price of preferred stock

0.045= $5/ P

p= $5/ 0.045

= $111.11.

Therefore, the price of the preferred stock is $111.11.

Question 28

The question is solved by first calculating the current price of the bond.

The price of the bond is calculated by computing the present value.

Information provided:

Future value= $1,000

Time= 15 years*2= 30 semi-annual periods

Coupon rate= 1%

Coupon payment= 0.01*1,000= $10

Yield to maturity= 2%/12= 0.1667%

Enter the below in a financial calculator to compute the present value:

FV= 1,000

PMT= 10

I/Y= 0.1667

N= 30

Press the CPT key and PV to compute the present value.

The value obtained is 1,243.65.

Therefore, the price of the bond is $1,243.65.

Current yield is calculated using the below formula:

Current Yield= Annual interest/Current price

= $10*2/ $1,243.65

= $20/ $1,243.65

= 0.0161*100

= 1.61%.