Question

Telewrk has 87,500 common shares trading at $75, and 12,000 preferred shares with a current price of $98. The common equity holders receive a quarterly dividend that grows at annual regular rate of 2%. Next year, this quarterly dividend will be $1.7325. Preferred shareholders also receive a quarterly dividend of $3.85. Debt completes Telewrk’s capital structure. The company has 11,000 bonds trading at $971.5, which pay an annual coupon of $103 and have 10 years to maturity. Telewrk’s tax rate is 20%. Calculate its WACC. You must show your work to get full points. 12 points

Answer 1

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of common stock * cost of common stock)

market value of debt = bonds outstanding * market price per bond

market value of debt = 11,000 * $971.5 = $10,686,000

market value of preferred stock = shares outstanding * market price per share

market value of preferred stock = 12,000 * $98 = $1,176,000

market value of common stock = shares outstanding * market price per share

market value of common stock = 87,500 * $75 = $6,562,500

total market value = $18,425,000

weight of debt = market value of debt / total market value

weight of debt = $10,686,000 / $18,425,000 = 0.5800

weight of preferred stock = market value of preferred stock / total market value

weight of preferred stock = $1,176,000 / $18,425,000 = 0.0638

weight of common stock = market value of common stock / total market value

weight of common stock = $6,562,500 / $18,425,000 = 0.3562

cost of debt = YTM of bond * (1 - tax rate)

YTM is calculated using RATE function in Excel with these inputs :

nper = 10 (10 years to maturity with 1 annual coupon payment each year)

pmt = 103 (annual coupon payment. This is a positive figure as it is an inflow to the bondholder)

pv = -971.50 (current bond price. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

The RATE is calculated to be 10.78%. This is the YTM.

cost of debt = YTM * (1 - tax rate)

cost of debt = 10.78% * (1 - 20%) ==> 8.62%

cost of preferred stock = annual dividend / current price

cost of preferred stock = ($3.85 * 4) / $98 = 15.71%

cost of common stock = (next year annual dividend / current price) + growth rate

cost of common stock = (($1.7325 * 4) / $75) + 2%

cost of common stock = 13.24%

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of common stock * cost of common stock)

WACC = (0.5800 * 8.62%) + (0.0638 * 15.71%) + (0.3562 * 13.24%)

WACC = 10.72%