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

Cost of equity

Next year, yearly dividend = Quaterly dividend × no. of quaters in a year

= 1.7325 × 4

= $6.93

Required return = dividend / price + growth rate

= 6.93/75 + 0.02

= 0.0924 + 0.02

= 0.1124 or 11.24%

Cost of preference stock

Annual dividend = Quaterly dividend × no. of quaters

= 3.85 × 4

= $15.4

Cost of preference share = annual dividend / current market price

= 15.4 / 98

= 15.71%

Cost of Debt

Using financial calculator to calculate the ytm

Inputs: N= 10

Pv= -971.50

Pmt= 103

Fv= -1,000

I/y= compute

We get, ytm of the bond as 10.78%

After tax cost of debt = ytm (1-tax rate)

= 10.78% (1-0.20)

= 10.78% (0.80)

= 8.62%

Calculating the weight of each

Equity = 87,500 × 75 = $6,562,500

Preference share = 12,000 × 98 = $1,176,000

Debt= 11,000 × 971.5 = $10,686,500

Total investment = $18,424,500

Weight of equity= 6,562,500/18,424,500 = 0.356

Weight of preference share= 1,176,000 / 18,424,500 = 0.064

Weight of debt= 10,686,500 / 18,424,500 = 0.58

Wacc= weight of debt × cost of debt + weight of preference share × cost of preference share + weight of equity × cost of equity

= 0.58 × 8.62% + 0.064 × 15.71% + 0.356 × 11.24%

= 5% + 1% + 4%

= 10%