Question

Johnston Corp has 10,000 bonds outstanding that were issued for 30 years ten years ago
at a par value of RM1,000.00 and a 12% coupon rate with interest being paid semiannually.
Similar bonds are now selling to yield 9%.

It issued 40,000 shares of 6% preferred stock with par value of RM100.00 eight years
ago. These preferred stocks are now selling to yield 10%.

There are currently 2,500,000 of common stocks outstanding, selling for RM11.60 per
share. Johnston Corp expects to pay a dividend of RM1.05 per share and dividends are
expected to grow at a constant growth rate of 5%.

Develop Johnston's market value based capital structure, and calculate its WACC.
Assume equity capital comes from retained earnings, and the tax rate is 40%.

Answer 1

To find the current bond price, we need to put the following values in the financial calculator:

INPUT	(30-10)*2=40	9/2=4.50		(12%/2)*1,000=60	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-1,276.02

So, Market Value of Debt = Current Price x No. of Bonds = RM1,276.02 * 10,000 = RM1,276,023.77

Current Preferred Stock Price = Annual Preferred Dividends / Yield = RM6/0.10 = RM60

So, Market Value of Preferred Stock = Current Price x No. of Stock

= RM60 * 40,000 = RM2,400,000

Market Value of Common Stock = Current Price x No. of Stock

= RM11.60 * 2,500,000 = RM29,000,000

Total Market Value = Market Value of Debt + Market Value of Preferred Stock + Market Value of Common Stock

= RM1,276,023.77 + RM2,400,000 + RM29,000,000 = RM32,676,023.77

wD = Market Value of Debt / Total Market Value = RM1,276,023.77/RM32,676,023.77 = 3.91%

wP = Market Value of Preferred Stock / Total Market Value

= RM2,400,000/RM32,676,023.77 = 7.34%

wE = Market Value of Common Stock / Total Market Value

= RM29,000,000/RM32,676,023.77 = 88.75%

After - tax kD = kD x (1 - t) = 9% - (1 - 0.40) = 5.40%

kP = 10%

kE = [D1 / P0] + g

= [RM1.05/RM11.60] + 0.05 = 0.0905 + 0.05 = 0.1405, or 14.05%

WACC = [wD x After-Tax kD] + [wP x kP] + [wE x kE]

= [0.0391 x 5.40%] + [0.0734 x 10%] + [0.8875 x 14.05%]

= 0.21% + 0.73% + 12.47% = 13.42%