Question

ABC Company is doing a project assessment and needs to know what it's weighted average cost of capital is for supporting its current operations. They will adjust it from there based on risk weighting the individual projects. The company has the following components to its capital structure:

A. Debt 3 Components:

$10,660,000 of long term bank debt at 6.75%.

$15,000,000 par value bonds at 4.75% with 15 year maturity and a sale price of 92% of par.

$8,750,000 par value bonds at 5.25% with an 8 year maturity and a sale price of 97% of par.

B. Preferred Stock is $17,600,000 in par value at $100 par value per share. Price per share is $111.75 and the annual payment is $4.20 per share.

C. Stock is selling for $52.85 per share and there are 1,150,000 shares outstanding. The company has a beta of 1.26, expected market premium of 8.2% and the risk free rate is 1.36.

1. Calculate the cost of debt.

2. Calculate the cost of preferred stock.

3. Calculate the cost of equity.

4. Calculate the weighted average cost of capital.

Answer 1

COST OF DEBT(K_d)=I(1-t)

I=Interest rate

t=Tax rate

tax rate is not given in question let us assume tax rate of 35%.

1) cost of long term loan at 6.75%

(6.75/100)*(10,660,000)=719550

K_d=(719550/10660000)*(1-.35)

=4.38%

2)Cost of bond issued at par

K_d=(I(1-t)+(Face value-Sales Value)/N)/(Face Value+Sales Value)/2

I=15000000*4.75%=712500

t=35%

FACE VALUE=15000000

SALES VALUE=15000000*92%=13800000

N=15

K_d=((712500(1-.35)+(15000000-13800000)/15)/(15000000+13800000/2)

K_d=3.77%

3)Cost of bond issued at par

K_d=((459375-(1-.35)+(8750000-8487500)/8)/(8750000+8487500)/2

K_d=3.84%

4)Kp=D_p/P₀(1-f)

Dividend or annual payment per year(Dp)=4.20$

P₀face value=100$

f(flotation cost)=11.75%

Kp=4.20/100(1-.1175)

Kp=4.20/88.25=4.75%

5)Cost of equity by CAPM approach

Ke=R_f+b(R_m-R_f)

Risk free rate=1.36%

Rm(rate of return on market)=8.2%

b(beta )=1.26%

Ke=1.36+1.26(8.2-1.36)=9.97%

Weighted average cost of capital=Kd(W1)+Kp(W2)+Ke(W3)

total cost of debt(Kd)=

cost of long term loan +cost of bond +cost of bond=4.38+3.77+3.84=11.99%

Weight of debt=113160000/191537500=59.07%

cost of debt	11.99%	113160000
cost of preference share	4.75%	17600000
cost of equity	9.97%	60777500

Cost of preference share(Kp)=4.75%

weight of preference share=17600000/191537500=9.18%

Cost of equity share(Ke)=9.97%

weight of equity share=60777500/191537500=31.73%

WACC=.1199*(.5907)+0.0475(0.0918)+0.0997(.3173)

WACC=0.0708+0.0043+0.0316

WACC=10.67%