In: Finance
Prudential Transportation has 600,000 shares of common stock outstanding at a market price of $25 a share. Last month, Prudential Transportation paid an annual dividend in the amount of $1.00 per share. The dividend growth rate is 5%. Prudential Transportation also has 21,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 5% coupon, pay interest annually, and mature in 10 years. The bonds are selling at 104% of face value. The company's tax rate is 25%. What is Prudential Transportation's weighted average cost of capital?
Market Value of Capital
Market Value of Debt = $2,18,40,000 [21,000 x ($1,000 x 104%)]
Market Value of Common Stock = $1,50,00,000 [600,000 x $25]
Total Market Value = $3,68,40,000
Weight of Capital to total market value
Weight of Debt = 0.5928
Weight of Common Stock = 0.4072
Cost of Capital Components
Cost of Debt
Cost of Debt = Yield to Maturity (YTM)
Yield to Maturity [YTM] = Coupon Amount + [(Face Value – Bond Price) / Maturity Years] / [(Face Value + Bond Price)/2]
= [$50 + [($1,000 $1,040) / 10 Years)] / [($1000 + $1,040)/ 2]] x 100
= [($50 - $4) / $1,020] x 100
= 4.49%
After Tax Cost of Debt = Bond’s YTM x [ 1 – Tax Rate]
= 4.49% x (1 – 0.25)
= 3.37%
Cost of Common Stock
Cost of Common Stock = [D1 / P0] + g
= [($1.00 x 1.05) / $25] + 0.05
= 0.0420 + 0.05
= 0.0920
= 9.20%
Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC) = [After-tax Cost of Debt x Weight of Debt] + [Cost of Common Stock x Weight of Common Stock]
= [3.37% x 0.5928] + [9.20% x 0.4072]
= 2% + 3.74%
= 5.74%
“Therefore, the Prudential Transportation's weighted average cost of capital = 5.74%”