Question

Slow Food has 400,000 shares of common stock outstanding. The common stock currently sells for $70 per share. It is expected that common stock will pay $3 dividend next year and its growth rate is 4 percent.

Fresh Food Company has 550,000 shares; 4% preferred stock outstanding. Preferred stock is currently sold at $95 per share and flotation (selling) cost is $2.

Fresh Food has 160,000 of 10 percent annual interest bonds outstanding, price is 95% of the par value and there are 20 years to maturity. (Par value of the bond is $1000)

Company (corporate) tax rate is 35 percent.

Calculate the Cost of debt   

Calculate the Cost of common stock

Calculate the cost of preferred stock debt

Calculate weighted average cost of capital WACC for Slow Food   Company

Answer 1

Answer :

Calculation of Cost of Debt

Cost of Debt

Using Excel function of Rate

=RATE(nper,pmt,pv,fv)

where nper is Number of years i.e 20

pmt is Interest payment i.e 1000 * 10% =100

pv is Current Market Price

= - 950 (1000 * 95%)

Note : pv should be taken as negative.

fv is face value i.e 1000

=RATE(20,100,-950,1000)

therefore ,Before tax cost of Debt is 10.612019%

After tax cost of Debt =10.612019% * (1 - Tax rate )

= 10.612019% * (1 - 0.35)

= 6.897812%

Calculation of Cost of Common Equity

Cost of Common Equity = [Expected Dividend / (Market Price )] + growth rate

= [3 / 70] + 0.04

= 0.08285714285 or 8.285714285%

Calculation of Cost of Preferred Stock

Cost of Preferred Stock = Annual Dividend / (Current Market Price - Flotation Cost)

= (100 * 4%) / (95 - 2)

= 0.04301075268 or 4.301075268%

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

Market Value of Equity = Number of Equity share * Price per share

= 400,000 * 70

= 28,000,000

Market Value of Preferred Stock = Number of Preferred share * Price per share

= 550,000 * 95

= 52,250,000

Market Value of Debt = Number of Bonds * Market Price per Bond

= 160,000 * 950

= 152,000,000

Total Market Value = 28,000,000 + 52,250,000 + 152,000,000

= 232,250,000

Weight of Equity = Market value of Equity / Total Market value

= 28,000,000 / 232,250,000

= 0.12055974165 or 0.1205

Weight of Preferred Stock = Market value of Preferred Stock / Total Market value

= 52,250,000 / 232,250,000

= 0.22497308934  or 0.2250

Weight of Debt= Market value of Debt / Total Market value

= 152,000,000 / 232,250,000

= 0.65446716899 or 0.6545

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

= [6.897812% * 0.6545] + ( 4.301075268%* 0.2250) + (8.285714285% * 0.1205)

= 4.5146% + 0.9677% + 0.9984%

= 6.4807 or 6.48%