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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 and your calculations in details. Please explain your calculations. Please do NOT use excel for your calculations.

Solutions

Expert Solution

(a): Here we will have to find the price of the bond. Price of the bond = present value of future cash flows using the market yield as discount rate. Semi-annual coupons = 7.2%/2 * 1000 = $36. Semi-annual YTM = 5.72%/2 = 2.86% and period = 25*2 = 50 semi-annual periods.

Thus price = 36/1.0286 + 36/1.0286^2 + 36/1.0286^3 + 36/1.0286^4 +……36/1.0286^50 + 1000/1.0286^50

= 36*PVIFA (2.86%, 50) + 1000*PVIF (2.86%, 50)

= 951.4074 + 244.1597

= 1,195.5671 (4 decimal place) or 1,195.57 (2 decimal place)

Now as there are 3,500 bonds then market value = 1,195.5671*3,500

= $4,184,484.74 (rounded to 2 decimal place)

(b): Market value of preference shares = 45,000 shares * $14.20

= $639,000.00

(c ): Market value of ordinary shares = 175,000 shares * $37

= $6,475,000.00

(d): Required rate of return on bonds = market yield*(1-t) = 5.72%*(1-30%) = 4.004%

(e): Dividend on preference shares = 8% of $15 = $1.20. Thus rate of return = 1.20/14.20

= 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): Total capital = 4,184,484.74 + 639,000 + 6,475,000 = $11,298,484.74

Thus WACC = (4,184,484.74/11,298,484.74 * 4.004%) + (639,000/11,298,484.74*8.45%) + (6,475,000/11,298,484.74*11.15%)

= 1.4829% + 0.4779% + 6.3899%

= 8.3508% (4 decimal place) or 8.35% (2 decimal place)

jeff jeffy answered 1 year ago
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