Question

Sound & Vision Studios (SVS) has 5 million common shares outstanding which sell for $30 per share. SVS just paid a dividend $2.50 per share, and investors and analysts expect all future dividends to grow by 5% per year, indefinitely. The current risk-free rate is 2.50%, the expected return on the market is 10%, and the stock has a beta of 2.2. SVS also has 1 million shares of 7% preferred stock outstanding (par value of $100) selling for $35 per share and 200,000 30-year, 9% annual coupon bonds outstanding, currently selling for 115% of par. If SVS is in the 35% tax bracket, then what is the firm’s WACC?

Answer 1

Answer to the question:

Calculation of WACC of SVS

Particulars	No. of shares/bonds	Market Price	Total value	Weight	WACC (weight*rate)
Common shares	5,000,000	$ 18.75 per share	$93,750,000	0.6178	11.7382%
Preferred Stock	1,000,000	$ 35 per share	$35,000,000	0.2306	4.612%
Bonds	200,000	$115 per bond	$23,000,000	0.1516	0.7712
Total			$151,750,000	1	17.1214%

Calculation of Rate of equity capital ;

Re = Risk Free Rate + (Market Rate of return - Risk free rate) * Beta

     = 2.50% + (10% - 2.50% ) 2.20

     = 19%

Market price of equity Shares = Dividend for next year / Re – growth rate

          = ($2.50*1.05) / 0.19 – 0.05

          = $ 18.75 per share

Calculation of Rate of preferred Stock (Rps)

Rps= Annual Dividend payment / Current market Price

Annual Dividend = 7% of face value of $ 100

                                = $7 per preference stock

Current market price = $ 35 per share

Therefore Rps = $ 7 / $35 per share

= 20%

Calculation of Rate of bonds;

Rate of bonds = Interest (1-tax rate)

                           Current market price

                           = 9 (1-0.35)

                           115 per bond

= 5.087%

From the above table we get that WACC of SVS is 17.1214%