Question

he CK Investment Bank has the following capital structure. What is the WACC for the company? Debt: Bond 1. 100,000 bonds with a coupon rate of 8% (paid semi-annually), a price quote of 120.0 and have 30 years to maturity. The semi- annual YTM is 3.24% Bond 2. 100,000 zero coupon bonds (semi-annual compounding) with a price quote of 30.0 and 20 years until maturity. Preferred stock: 200,000 shares of 5 percent preferred stock with a current price of $70, and a par value of $100. Common stock: 5,000,000 shares of common stock, with a price of $60, and a beta of 1.2. Market: The corporate tax rate is 40 percent, the market risk premium is 8%, and the risk-free rate is 3%.

Answer 1

YTM of Bond 2 zero coupon bond by using excel function

=Rate (nper,pmt,fv,pv)

=Rate(40,0,-300,1000)

=3.06% ( this is semi-annual)

So, Annual Ytm = 6.12%

After tax YTM = 6.12%*0.60 = 3.67%   

Bond 1

Calculation After tax yield = 3.24%*2*(0.60) [Given 3.24 = YTM, 2 because semi annual, 1-0.40(tax rate )]

= 3.88%

Now ,

Cost of equity

where rf= risk free rate , beta , (rm - rf) = market risk premium

= 3% + 1.2 *8%

=12.6%   

Cost of preferred stock

where Dp is yearly dividend and P0 is current preference share price

= 100*5/70

= 7.14%

Now we will calculate weights of Debt, equity and preference share

market value of bond 1 = 100000*120 = 1,20,00,000

market value of zero coupon bond = 100000*30 = 30,00,000

market value of preference = 200000*70 = 1,40,00,000

Market value of equity = 5000000*60 = 30,00,00,000

Total MV = 32,90,00,000

WACC = [cost of zero coupon bond * weight of debt ]+[cost of equity * weight of equity ]+[cost of preferred  * weight of preferred  ]+ [ cost of debt * weight of debt ]

= [3.67% * 30,00,000/329000000] + [3.88 % * 12000000/329000000] +[12.6% * 300000000/329000000]+ [7.14% * 1,40,00,000/329000000]

=11.96%