Question

At 2018 ABI Construction has a face debt value of 26.82M trading at 86% with a pre-tax weigthed cost of 6.18%. ABI common equity for the year was valued at 95.28M and preferred equity for 11.49M. The Preferred equity rate was calculated to be 8.48%. However, the common equity was to be calculated using CAPM approach, with a 3% risk free rate and a 7% market risk premium rate, assuming a 1.39 Beta. If the tax rate is 41%, What is this firm’s WACC?

Answer 1

- Market Value of debt = Face value of debt*Trading Price

= $26.82M*86%

Market Value of debt = $23.0652M

- Market Value of equity = $95.28M

- Market Value of Preferred Equity = $11.49M

Total Capital Structure = Market Value of Debt + Market Value of equity + Market Value of preferred equity

Total Capital Structure = $23.0652M+ $95.28M+ $11.49M

Total Capital Structure = $129.8352M

- Before-Tax cost of debt = 6.18%

- Cost of Preferred Equity = 8.48%

As per CAPM Method,

where, rf = Risk free return = 3%

Rmp = Market Risk Premium = 7%

Beta = 1.39

Required rate of Return = 3% + 1.39(7%)

Required rate of Return or Cost of equity= 12.73%

- Calculating WACC of firm:-

WACC= (Weight of Debt)(Before-tax Cost of Debt)(1-Tax rate) + (Weight of Common stock)(Cost of Retained earnings) +(Weight of Preferred Stock)(Cost of Preferred Stock)

WACC = (23.0652M/129.8352M)(6.18%)(1-0.41) + (95.28M/129.8352M)(12.73%) + (11.49M/129.8352M)(8.48%)

WACC = 0.6477% + 9.3420% + 0.7505%

Firm's WACC = 10.74%

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