Question

*This is all part of a single question*

Given the following information on Ke-Ma-Gen Ltd., what is its WACC?  

Debt:

• Number of bonds = 10,000
• Par value = $1,000
• Coupon rate = 9% (semi-annual coupons)
• Time to maturity = 10 years
• Market value = 98% of par

Common equity:

• Number of shares outstanding = 1,000,000
• Par value = $1
• Price per share = $3.50
• Dividends per share = $0.70

Preferred equity:

• Number of shares outstanding = 50,000
• Price per share = $20
• Dividend yield = 5%

Other information:

• Tax rate = 40%
• Equity beta = 1.2
• Market risk premium = 16%
• Risk-free rate = 5%

Answer 1

Capitals	Number of Bonds/Shares	Market Value per Bond/Share	Market Value	Weight to total market value
Bond	10,000	980.00	98,00,000	0.6853
Preferred Stock	50,000	20.00	10,00,000	0.0699
Common Stock	10,00,000	3.50	35,00,000	0.2448
TOTAL			1,43,00,000	1.0000

After-Tax Cost of Debt

The After-tax Cost of Debt is the after-tax Yield to maturity of the Bond

The Yield to maturity of (YTM) of the Bond is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables	Financial Calculator Keys	Figure
Face Value [$1,000]	FV	1,000
Coupon Amount [$1,000 x 9.00% x ½]	PMT	45
Yield to Maturity [YTM]	1/Y	?
Time to Maturity [10 Years x 2]	N	20
Bond Price [-$1,000 x 98%]	PV	-980

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get the yield to maturity (YTM) on the bond = 9.31%

After Tax Cost of Debt = Yield to maturity x (1 – Tax Rate)

= 9.31% x (1 – 0.40)

= 9.31% x 0.60

= 5.59%

Cost of Preferred Stock

Cost of Preferred Stock = [Preferred Dividend / Selling Price] x 100

= [($100 x 5%) / $20] x 100

= [$5.00 / $20.00] x 100

= 25.00%

Cost of Equity

As per Capital Asset Pricing Model [CAPM], the cost of equity is calculated by using the following equation

Cost of equity = Risk-free Rate + [Beta x Market Risk Premium]

= 5.00% + [1.20 x 16.00%]

= 5.00% + 19.20%

= 24.20%

Weighted Average Cost of Capital (WACC)

Therefore, the Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

= [5.59% x 0.6853] + [25.00% x .0699] + [24.20% x .2448]

= 3.83% + 1.75% + 5.92%

= 11.50%

“Therefore, the Weighted Average Cost of Capital (WACC) will be 11.50%”