Question

Ma, Inc. has a market value capital structure of 30% debt and 70% equity. The tax rate is 40%. The firm’s bonds currently trade in the market for $930. These bonds have a face value of $1,000, coupon rate of 8% paid semiannually, and 10 years remaining to maturity. The firm’s common stock trades for $20 per share. The firm has just paid a dividend of $2. Future dividends are expected to grow at 3% per year. Based on this information, Ma, Inc.’s WACC is?

Answer 1

		COST OF EQUITY:
		Assume,Required rate of return=R
		Dividend growth rate=g=3%=	0.03
		Expected dividend next year=D1	$2.06	($2*(1+0.03))
		Current price of stock=P0=	$20
		P0=D1/(R-g)
		20=2.06/(R-0.03)
		R-0.03=2.06/20=	0.103
		R=Required Rate of Return=0.103+0.03	0.133
		Required Rate of return=Cost of capital	13.30%
	Ce	Cost of Equity:	13.30%
		COST OF DEBT
		Face value of Bond	$1,000
		Semi annual coupon rate=(8/2)%	0.04
	Pmt	Semi annual coupon payment	$40	(1000*0.04)
	Pv	market value of bond	$930
	Nper	Semi annual periods to maturity	20	(10*2)
	Fv	Payment at maturity	$1,000
	RATE	Semi annual yield to maturity	4.54%	(Using RATE function of excel with Nper=20,Pmt=40,Pv=-930, Fv=1000)
		Semi annual yield to maturity	0.04540
		Effective annual yield=((1+0.0454)^2)-1	0.092861
		Cost of Debt	0.092861
		Before tax Cost of Debt in percentage	9.29%
	Cd	After tax cost of debt =9.29*(1-0.4)=	5.57%
	We	Weight of equity in capital structure	0.7
	Wd	Weight of debt in capital structure	0.3
		WACC=Weighted Average Cost of Capital
		WACC=We*Ce+Wd*Cd=0.7*13.3+0.3*5.57=	10.98%
		WACC=10.98%