Question

At 2018 ABI Construction has a face debt value of 27.02M trading at 87% with a pre-tax weigthed cost of 5.36%. ABI common equity for the year was valued at 115.1M and preferred equity for 11.94M. The Preferred equity rate was calculated to be 8.92%. 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 1.37 Beta. If the tax rate is 38%, What is this firm’s WACC?

Answer 1

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

= $27.02M*87%

= $23.5074M

- Market Value of equity = $115.1M

- Market Value of Preferred Equity = $11.94M

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

Total Capital Structure = $23.5074M + $115.1M + $11.94M

Total Capital Structure = $150.5474M

- Before-Tax cost of debt = 5.36%

- Cost of Preferred Equity = 8.92%

As per CAPM Method,

where, rf = Risk free return = 3%

Rmp = Market Risk Premium = 7%

Beta = 1.37

Required rate of Return = 3% + 1.37(7%)

Required rate of Return = 12.59%

So, Cost of equity = 12.59%

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 = (23.5074M/150.5474M)(5.36%)(1-0.38) + (115.1M/150.5474M)(12.59%) + (11.94M/150.5474M)(8.92%)

WACC = 0.5189% + 9.6256% + 0.7075%

Firm's WACC = 10.85%