Question

The Saunders Investment Bank has the following financing outstanding. Debt: 20,000 bonds with a coupon rate of 10 percent and a current price quote of 108.0; the bonds have 20 years to maturity. 190,000 zero coupon bonds with a price quote of 19.5 and 30 years until maturity.

Preferred stock: 110,000 shares of 8 percent preferred stock with a current price of $83, and a par value of $100.

Common stock: 2,200,000 shares of common stock; the current price is $69, and the beta of the stock is 1.35.

Market: The corporate tax rate is 40 percent, the market risk premium is 7 percent, and the risk-free rate is 4 percent.

What is the WACC for the company? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

WACC

%

Answer 1

Market Value of Coupon Bonds = Bond Price x No. of bonds outstanding

= 108% x $1,000 x 20,000 = $21,600,000

Market Value of Zero-Coupon bonds = Bond Price x No. of bonds outstanding

= 19.5% x $1,000 x 190,000 = $37,050,000

Market Value of Preferred Stock = Share Price x No. of shares outstanding,

= $83 x 110,000 = $9,130,000

Market Value of Common Stock = Share Price x No. of shares outstanding

= $69 x 2,200,000 = $151,800,000

Total Market Value of the firm = Market Value of Coupon Bonds + Market Value of Zero-Coupon Bonds +

Market Value of Preferred Stock + Market Value of Common Stock

= $21,600,000 + $37,050,000 + $9,130,000 + $151,800,000 = $219,580,000

wCB = Market Value of Coupon Bonds / Total Market Value of the firm = $21,600,000/$219,580,000 = 9.84%

wZB =  Market Value of Zero-Coupon Bonds / Total Market Value of the firm = $37,050,000/$219,580,000 = 16.87%

wP = Market Value of Preferred Stock / Total Market Value of the firm = $9,130,000/$219,580,000 = 4.16%

wE = Market Value of Common Stock / Total Market Value of the firm = $151,800,000/$219,580,000 = 69.13%

To find the kCB, we need to put the following values in the financial calculator:

INPUT	20		-1,080	(10%)*1,000=100	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		9.12

After-Tax kCB = kCB x (1 - t) = 9.12% x (1 - 0.40) = 5.47%

kZC = [FV / PV]^1/n - 1 = [(1,000/195)^1/60 - 1] x 2 = [1.0276 - 1] x 2 = 0.0276 x 2 = 0.0552, or 5.52%

After-Tax kZC = kZC x (1 - t) = 5.52% x (1 - 0.40) = 3.31%

kP = Annual Dividend / Current Market Price = $8 / $83 = 0.0964, or 9.64%

kE = rF + beta[Market Risk Premium] = 4% + 1.35[7%] = 4% + 9.45% = 13.45%

WACC = [wCB x After-Tax kCB] + [wZC x After-Tax kZC] + [wP x kP] + [wE x kE]

= [0.0984 x 5.47%] + [0.1687 x 3.31%] + [0.0416 x 9.64%] + [0.6913 x 13.45%]

= 0.54% + 0.56% + 0.40% + 9.30% = 10.80%