Question

2. A firm raises capital with issuing debt (60%) and prefer stocks (40%). It will sell a 12-year bond with 9% coupon rate that will semiannually be paid. The firm is about to sell prefer stock that has $100 par value and pays 12.8 % of par value as dividend per year. Its current BOND price is set to $120 and floatation cost of this issuance is 3%. (tax rate is 40%)
   1. Compute cost of debt
3. Compute cost of prefer stock
4. What is its cost of capital (WACC)

Answer 1

flotation adjusted bond price = bond price*(1-cost of floatation)

=120*(1-0.03) = 116.4

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =12x2

116.4 =∑ [(9*100/200)/(1 + YTM/200)^k]     +   100/(1 + YTM/200)^12x2

k=1

YTM% = 6.96

cost of prefered equity = dividend/price = 12.8/100 = 12.8%

WACC

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

After tax cost of debt = 6.96*(1-0.4)

'= 4.176

Weight of equity = 1-D/A

Weight of equity = 1-0.6

W(E)=0.4

Weight of debt = D/A

Weight of debt = 0.6

W(D)=0.6

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=4.18*0.6+12.8*0.4

WACC% = 7.63