Question

Balance Sheet Data

               Long-Term Debt               80,000,000

               Preferred Stock                20,000,000

               Common Equity                20,000,000

Number of shares of Common                 1,500,000                         Price per share Common             $42

Number of shares of Preferred                     150,000                               Price per share Preferred            $108

Number of 8% Coupon 25-year Bonds          40,000               Price of 8% 25-year Bonds   $1075

Number of 6% Coupon 15-year Bonds          40,200                           Price of 6% 15-year Bonds   $920

Forecasted Dividend on Common (D₁)             $3.30                           Dividend Rate on Preferred            9.5%

Par Value of Preferred                                           $100                                 Current 10-Year Treasury Yld.        4.3%

Standard Deviation of Stock                                   40%                              Correlation Stock vs. Market 0.50

Standard Deviation of Market                                15%                      Market Risk Premium                    5.0%

Risk Premium of our Stock over our 15-yr Bonds          3.9%        Forecasted Constant Growth             3.0%

Tax Rate                                                                       25%                        Flotation costs on Bonds               1.4%

Flotation costs on Preferred                                   2.4%

Please show step by step!

1. Calculate the appropriate weights to use for the financing sources. (Hint: Assume that the firm feels their current mix of long-term debt is good and would like to raise capital with the same mix of maturities)
2. Calculate the after-tax cost of debt (hint: You can account for the two bonds by taking a weighted average of their cost or by keeping them separate and putting both into the WACC formula at their individual weights). Note that there are flotation costs of 1.4% on bonds.
3. Calculate the cost of preferred. Note that there are flotation costs of 2.4% on preferred stock.
4. Calculate the cost of common (Hint: Use all three methods and take an average). Note that all common equity will come from internally generated equity (retained earnings) which means no new shares will be issued and no flotation costs incurred.
5. Calculate the WACC

Answer 1

calculation of Cost of Debt: -

Par value = 1,000

Present Value = 1075*(1-1.20%) = 1062.10

Semi-annual Payment = 1000*8%/2 = 40

Period = 25*2 = 50

Rate = 3.72%

Annual Yield to Maturity = 3.72%*2 = 7.45%

6%, 15-year debts

Cost of debt: -

similarly,

Rate = 3.49%

Yield to maturity = 6.99%

cost of Preferred stock: -

= (1000*9.50%)/(108*(1 - 2.20%)) = 8.99%

WACC =

Weights Cost

Debt 50.25% 5.43%

Pref. stock 10.18% 8.99%

Equity 39.58% 8.88%

Total WACC 7.16%