Question

Easy Sleazy Recliner Corp. has a capital structure including the following: 50,000 bonds selling for $1,140, original maturity of 30-years, 12-years old, par = $1,000, paying an annual coupon rate of 8%. Also, 140,000 shares of 5% preferred stock, par value = $100, market price = $120; and 1 million shares of common stock. ESR's beta is 0.92, risk free rate = 2%, market return = 12%. Market price is $42/share. Tax rate = 21%. What is the WACC?  

Answer 1

Answer = 7.37%

Notes:

Value of Bond = 50,000 Bonds * $ 1140

Value of Preferred Stock = 140,000 Shares * $ 120

Value of Equity = 1 Million Shares * $ 42

Cost of Preferred Stock = 5%

Cost of Equity = risk free rate + (market return- risk free rate)*beta

=2%+(12%-2%)*0.92

= 11.20%

The Approximate Yield to Maturity Formula =[Coupon + ( Face Value - Market Price) / Number of years to maturity] / [( Face Value + Market Price)/2 ] *100

Since this formula gives an approximate value, the financial calculators can be used alternatively.

where,

Par Value = $ 1,000

Market Price = $  1140

Annual rate = 8% and

Maturity in Years = 18 Years

Hence the yield to maturity = 6.64%

Now, the after tax cost of debt = Yield to Maturity * (1- tax Rate)

= 6.64% * ( 1-21%)

= 5.2456%

WACC = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)+ (Cost of Preferred Stock * Weight of Preferred Stock )

= 7.37%

Answer = 7.37%

	Value	Weight(value / total)	Cost	Weight * cost
Bond	5,70,00,000.00	49.2228%	5.2456%	2.58 %
Equity	4,20,00,000.00	36.2694%	11.20%	4.06 %
Preferred Stock	1,68,00,000.00	14.5078%	5%	0.73 %
	11,58,00,000.00		WACC=	7.37 %