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            Cita Company’s target capital structure is 40 percent debt, 50 percent common stock, and 10...

            Cita Company’s target capital structure is 40 percent debt, 50 percent common stock, and 10 percent preferred stock. Information regarding the company’s cost of capital can be summarized as follows:

  • Company sold a non-callable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $1,025, and has a par value of $1,000.
  • The company’s preferred stock currently sells for $81.88 per share, and it pays an $8.10 annual dividend.
  • The company is expected to pay $1.45 dividend per share at the end of this year. Financial analysts believe that the company is expected to grow at a constant rea of 6.50 percent in future years.                           

The stock of the company is currently selling for $21.50

  • The company’s tax rate is 40
  • What is the Cita Company’s weighed average cost of capital (WACC)?

Solutions

Expert Solution

Cost of debt: Period to maturity = 20*2 = 40, periodic coupon = 9.25%/2*1000 = 46.25. PV = 1,025. We need to compute this bond's YTM and this can be done using the "rate" function in excel.

Thus YTM = rate(40, 46.25, -1025, 1000). This gives a value of 4.489%. This will be multiplied with 2 since the computatuion has been done for the 6 monthly period. Hence YTM = 4.489%*2 = 8.9787%. Thus after tax cost of debt = (1-40%)*8.9787% = 5.3872%

Cost of preference shares = annual dividend/current price = 8.10/81.88 = 9.8925%

Cost of equity: Here D1 = 1.45. Note that this dividend is expected to be paid at the end of the year and hence it will be D1 and not D0 as it is not the curent dividend. Now we know that P0 = D1/(r-g)

or 21.50 = 1.45/(r-6.5%)

or r-6.5% = 6.7442%

or r = 13.2442%

Thus WACC = (40% * 5.3872) + (10% * 9.8925) + (50% * 13.2442)

= 9.77%

Thus WACC = 9.77% (rounded to 2 decimal place)

jeff jeffy answered 2 years ago
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