Question

TAFKAP Industries has three million shares of common stock outstanding selling at $17 per share. The company recently paid a dividend of $1 and has a growth rate of 5%. The company also has an issue of $20 million (face value) in 7.5 percent, annual coupon bonds with a maturity of 15 years, selling at $1060. The company has no preferred stock. If TAFKAP’s weighted average tax rate is 34 percent, what is TAFKAP’s WACC?

Answer 1

i) Curent Price = 1040

Annual Coupn = 7.5% x 1000 = 75 / year till 15 years

Redeemable Value = 1000 after 15 years

Lets assume YTM = i ( yield to maturity or cost of bond)

We know, current price is present value of all future casflows

1060 = 75 x[ 1-(1+i)^-15] + 1000/(1+i)¹⁵

Doing trial and error method or using goal seek fundtion of xcel we find YTM = i = 6.85 % which is cost of debt

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We know Return on equity = Div (1+div growth) / Price + Div growth

ROE = 1 x(1+.05)/17 + .05 = 11.18%

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Market Value of Debt = 20 million

Market value Equity = 3 million x 17 = 51 miilion

Total value = 20 + 51 = 71 million

Debt Proportion = 20/71 = 28.17 % ; Equity Value = 51/71 = 71.83 %

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WACC = Proportion of debt x cost of debt x ( 1- tax) + proportion of equity x cost of equity

= 28.17% x 6.85 % x (1-.34 ) + 71.83% x 11.18 % = 9.30%

Coupn / Year		Current	Maturity
(%)	Value/ Year	Price	Years	YTM
7.50%	75	1060	15	6.85%

	Value(Million)	Cost	Proportion	Tax	Afer tax cost = Costof return (1-tax rate)
Debt	20	6.85%	28.17%	34%	1.27%
Equity	51	11.18%	71.83%	0	8.03%
Total Value	71			WACC	9.30%