Question

Sanders and Marks, Inc. currently has 1,000,000 common shares outstanding that are currently trading at $55 per share. When the shares were originally issued one year ago, their price was $20. The Beta of the company is 1.1 and the market risk premium is 4.5%. The company also has 250,000 shares of preferred stock outstanding for which it pays an annual dividend of $2.50 per share. These preferred shares currently trade at $60 per share. Sanders and Marks has also just issued 3,000 bonds that are currently valued at 94% of par and have a yield-to-maturity of 6.42%. The company is in the 21% tax bracket. Treasury bills currently yield 6%.

1.       What is the weight associated with the company’s debt at market value?

2.       What is the WACC of the company at market value?

Answer 1

Market value of the equity/common stock=Number of common shares* current price of share=1000000*55=$55,000,000

Market value of the preferred stock=Number of preferred shares*price of each prefered share=250000*60=$15,000,000

Market value of the bonds=Number of bonds*market price of each bond=3000*$940=$2,820,000 (given currently valued at 94% of par=940)

==> total value=$55,000,000+$15,000,000+$2,820,000=$72,820,000

Weight of common stock=$55,000,000/$72,820,000=75.5%

Weight of prefered stock=$15,000,000/$72,820,000=20.6%

Weight of debt=$2,820,000/$72,820,000=3.9%

Cost of common stock=risk free rate+(beta*market risk premium)=6%+(1.1*4.5%)=10.95%

Cost of prefered stock=Dividend/Current price=2.5/60=4.17%

Cost of debt=yield to maturity*(1-tax rate)=6.42%*(1-21%)=5.07%

Weighted average cost of capital=(weight of debt*cost of debt)+(weight of prefered stock*cost of prefered stock)+(weight of common stock*cost of common stock)

WACC=(3.9%*5.07%)+(20.6%*4.17%)+(75.5%*10.95%)=9.33%