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Use the following information to answer the questions below that are required to ultimately calculate a...

Use the following information to answer the questions below that are required to ultimately calculate a company’s WACC:
- Long-term bonds: 3,500 bonds outstanding with 7.20% p.a. coupons paid semi-annually, $1000 face value, 25 years to maturity, current market yield is 5.72% p.a.

- Preference shares: pay a dividend of 8% p.a. forever on a $15 face value, 45,000 outstanding, currently selling for $14.20 per share.

- Ordinary shares: 175,000 shares outstanding selling for $37 per share with beta of 1.15.

Other information: Market risk premium = 7%, risk-free rate = 3.1% p.a., company tax rate = 30%.
(a) What is the total market value of the bonds?
(b) What is the total market value of preference shares?
(c) What is the total market value of ordinary shares?
(d) What is the required rate of return on bonds?
(e) What is the required rate of return on preference shares?
(f) What is the required rate of return on ordinary shares?
(g) What is the weighted average cost of capital?

Important: Please show formulas. Please explain thoroughly your answers and calculations.

Solutions

Expert Solution

a. first we have to find the current price of the bond and can be found using PV function in EXCEL

=PV(rate,nper,pmt,fv,type)

Here, the payments are semi-annual

rate=market yield/2=5.72%/2=2.86%

nper=2*25=50

pmt=semi-annual coupon payment=(7.2%*1000)/2=36

fv=1000

=PV(2.86%,50,36,1000,0)

PV=market price of the bond=$1195.57

Market value of the bonds=Number of bonds*market price of each bond=3500*$1195.57=$4,184,485

b. Market value of the preferred shares=Number of preferred shares*price of each prefered share=45000*$14.2=$639,000

c. Market value of ordinary shares=Number of ordinary shares*price of ordinary share=175000*$37=$6,475,000

==> total value=$4,184,485+$639,000+$6,475,000=$11,298,485

Weight of debt=$4,184,485/$11,298,485=37.0%

Weight of prefered shares=$639,000/$11,298,485=5.7%

Weight of ordinary shares=$6,475,000/$11,298,485=57.3%

d. required rate of return on bonds=yield to maturity*(1-tax rate)=5.72%*(1-30%)=4.0%

e. required rate of return on prefered shares=Dividend/Current price=(8%*15)/14.2=8.45%

f. required rate of return on ordinary shares=risk free rate+(beta*market risk premium)=3.1%+(1.15*7%)=11.15%

g. Weighted average cost of capital=(weight of debt*required rate on debt)+(weight of prefered shares*required rate on prefered shares)+(weight of ordinary shares*required rate on ordinary shares)

WACC=(37.0%*4.0%)+(5.7%*8.45%)+(57.3%*11.15%)=8.35%

jeff jeffy answered 1 year ago
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