Question

The Carrot Investment Bank has the following financing outstanding. What is the WACC for the company?

Debt: 70,000 bonds with a coupon rate of 8 percent and a current price quote of 110.5; the bonds have 20 years to maturity. 300,000 zero coupon bonds with a price quote of 18.5 and 30 years until maturity.

Preferred Stock: 200,000 shares of 5 percent preferred stock with a current price of $80, and a par value of $100

Common Stock: 3,000,000 shares of common stock, the current price is $70, and the beta of the stock is 1.15

Market: The corporate tax rate is 40 percent, the market risk premium is 7 percent, and the risk free rate is 4 percent

Answer 1

Solution :-

Par Value of a Coupon Bond = $100

Coupon Amount = $100 * 8% = $8

Now Price of Bond ( PV ) = $110.50

Time to Maturity = ( N ) = 20

Cost of Coupon Bond ( Kd ) = 7.01%

After Tax Kd = 7.01% * ( 1 - 0.40 ) = 4.206%

Now in case of Zero Coupon Bond

Coupon Payment = 0

Time to Maturity ( N ) = 30

Price ( PV ) = $18.5

Face Value ( FV )= $100

Now Cost of Zero Coupon Bond ( Zd ) = 5.79%

After tax Cost of Zero Coupon Bond = 5.97% * ( 1 - 0.40 ) = 3.582%

Cost of Preferred Stock ( kp )= Dividend / Price = $100 *5% / 80 = 5 / 80 = 0.0625 = 6.25%

Cost of Equity (Ke ) = Rf + Beta ( Risk Premium )  

= 4% + 1.15 * ( 7% )

= 12.05%

Therefore Weighted Average Cost of Capital = 11.21%
If there is any doubt please ask in comments

Thank you please rate