Question

You are about to start to consider a batch of

new capital budgeting projects. Before you begin,

you need to estimate your company’s

Weighted-Average-C

ost-of-Capital

(WACC). The firm

operates in the 35% marginal

tax bracket. There are

four

sets of liability

holders on the balance

sheet. Calculate the WACC including

all four classes of liabilities.

A.

There are 8.760,000 shares of

common stock

outstanding. These ar

e trading at $52.56

per share. You have decided to use the Go

rdon Growth Model to estimate the return

required by your firm’s shareholders. In the

most recent annual report the earnings per

share (EPS) were $4.35. You feel that it is reas

onable to assume that earnings will grow

at about 1.10% into the foreseeable future.

B.

There is an issue of 3,825,000 shares of

preferred stock

. These securities promise an

(perpetual) annual divide

nd of $1.85. The shares are

currently trading for $24.72.

C.

There is an issue of 158,000

coupon bonds

, which have a face value of $1,000, pay

4.65% (annual) coupons, and mature in 15 years.

The securities are cu

rrently trading for

$1,072.27.

D.

The firm also has 70 short-term

commercial paper notes

outstanding that have a face

value of $1,000,000, and mature in 35 days. These are currently selling for $997,915.46.

Answer 1

Equity

Market Capitalization = 8,760,000 × $52.56

= $460,425,600

Market capitalization is $460,425,600.

Cost of equity = [$4.35 × (1+ 1.10%) / $52.56] + 1.10%

= ($4.39875 / $52.56) +1.10%

= 8.37% + 1.10%

= 9.47%

Cost of equity is 9.47%.

Preferred stock

Market value of preferred stock = 3,825,000 × $24.72

= $94,554,000

Market value of preferred stock is $94,554,000.

Cost of preferred stock = $1.85 / $24.72

= 7.48%

Cost of preferred stock is 7.48%.

Bond

Market value of bond = 158,000 × $1,072.27

= $135,618,500

Market value of bond is $169,418,660.

YTM of bond that is before tax cost of bond is calculated in excel and screen shot provided below:

Before tax cost of debt is 4.00%

Tax rate = 35%

After tax cost of long term debt = 4.00% × (1 - 35%)

= 2.60%

After tax cost of long term debt is 2.60%

Short term debt

Market value of short term debt = 70 × $997,915.46

= $69,854,082

Market value of short term debt is $69,854,082.

Cost of short term debt = [($1,000,000 / $997,915.46) ^ (360 / 35)] - 1

= 1.0217 - 1

= 2.17%

Cost of short term debt is 2.17%.

Market value of total capital = $460,425,600 + $94,554,000 + $169,418,660+ $69,854,082

= $794,252,342.

Market value of total capital is $794,252,342.

Weight of equity = 57.97%

Weight of preferred stock = 11.90%

Weight of long term debt = 21.33%

Weight of short term debt = 8.79%.

Now, WACC is calculated below:

WACC = (57.97% × 9.47%) + (11.90% × 7.48%) + (21.33% × 2.60%) + (8.79% × 2.17%)

= 5.49% + 0.89% + 0.55% + 0.19%

= 7.13%

WACC of company is 7.13%.