Question

The Saunders Investment Bank has the following financing outstanding.

Debt:

150,000 bonds with a coupon rate of 11 percent and a current price quote of 108; the bonds have 20 years to maturity. 320,000 zero coupon bonds with a price quote of 16 and 30 years until maturity. Assume semiannual compounding.

Preferred stock:

240,000 shares of 9 percent preferred stock with a current price of $67, and a par value of $100.

Common stock:

3,500,000 shares of common stock; the current price is $53, and the beta of the stock is .9.

Market:

The corporate tax rate is 25 percent, the market risk premium is 8 percent, and the risk-free rate is 5 percent. What is the WACC for the company?

Answer 1

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

Before tax cost of debt is 10.06%.

Before tax cost of zero coupon debt = [($1,000 / $160) ^ (1 / 60) - 1] × 2

= (1.0310 - 1) × 2

= 6.20%

Before tax cost of zero coupon debt is 6.20%.

Market value of coupon paying debt = 150,000 × $1,000 × 106%

= $162,000,000

Market value of zero coupon bond = $320,000 × $1,000 × 16%

= $51,200,000

Market value of total debt = $162,000,000 + $51,200,000

= $213,200,000

Market value of total debt is $213,200,000.

Weight of coupon paying debt = 75.98%

Weight of zero coupon debt = 24.02%

Weightage average cost of debt = (75.98% × 10.02%) + (24.02% × 6.20%)

= 7.65% + 1.49%

= 9.14%

Weightage average before tax cost of debt is 9.14%.

Tax rate = 25%

After tax cost of debt = 9.14% × (1 - 25%)

= 6.85%

After tax cost of debt is 6.85%.

Preferred stock

Cost of preferred stock = $9 / $67

= 13.43%

Cost of preferred stock is $13.43%.

Market value of preferred stock = 240,000 × $67

= $16,080,000

Market value of preferred stock is $16,080,000.

Common Equity

Cost of equity = 5% + (8% × 0.9)

= 5% + 7.20%

= 12.20%

Cost of equity is 12.20%.

Market value of equity = 3,500,000 × $53

= $185,500,000.

Market value of equity is $185,500.

WACC

Market value of total capital = $213,200,000 + $16,080,000 + $185,500.000

=$414,780,000

Weight of debt = 51.40%

Weight of preferred stock = 3.88%

Weight of equity = 44.72%

Now, WACC is calculated below:

WACC = (51.40% × 6.85%) + (3.88% × 13. 43%) + (44.72% × 12.20%)

= 3.52% + 0.52% + 5.46%

= 9.50%

WACC of comapny is 9.50%.