Question

SCTYQ issued 9,000 bonds 5 years ago with 30 years to maturity when they were issued. The coupon rate is 2.4% and coupons are paid annually. The current price of each bond is $568.81. In addition, there are 500,000 shares of common stock outstanding with a market price of $21 per share. SCTYQ’s beta is .90 the risk-free rate is 2%. SCTYQ is expected to pay a dividend of $1.06, with a 6% growth rate Assume a tax rate of 40%. There are 50,000 preferred shares paying a dividend of $2.00. The current price per preferred share is $10. Calculate the WACC for SCTYQ.

Answer 1

Caculation of Cost of Debt

Using Financial Calculator

=RATE(nper,pmt,pv,fv)

where nper is Number of years to maturity i.e 25 (30 - 5)

pmt is Interest payment i.e 1000 * 2.4% =24

pv is Current Market Price

= - 568.81

Note : pv should be taken as negative.

fv is face value i.e 1000 (Assumed)

=RATE(25,24,-568.81,1000)

therefore ,Before tax cost of Debt is 5.66711%

After tax cost of Debt = 5.66711 * (1 - Tax rate )

= 5.66711 * (1 - 0.40)

= 3.40027%

Calculation of Cost of Equity

Cost of Common Equity = [Expected Dividend / (Market Price - Flotation Cost)] + growth rate

= [1.06 / 21] + 0.06

= 0.11047619047 or 11.04762%

Calculation of Cost of Preferred Stock

Cost of Preferred Stock = Annual Dividend / Current Market Price

= 2 / 10

= 0.20 or 20%

Calculation of Weight of Equity and Debt of the firm :

Market Value of Equity = Number of Equity shares * Price per share

= 500,000 * 21

= 10,500,000

Market Value of Debt = Number of Bond Outstanding * Price per Bond

= 9,000 * 568.81

= 5,119,290

Market Value of Equity = Number of Preferred Stock * Price per share

= 50,000 * 10

= 500,000

Total Market Value = 10,500,000 + 5,119,290 + 500,000

= 16,119,290

Weight of Equity = Market Value of Equity / Total Market Value

= 10,500,000 / 1,6119,290

= 0.65139345467 or 0.6514

Weight of Debt = Market Value of Debt / Total Market Value

= 5119290 / 16119290

= 0.31758780938 or 0.3176

Weight of Preferred Stock = Market Value of Preferred Stock / Total Market Value

= 500,000 / 1,6119,290

= 0.031010873593 or 0.0310

Calculation of WACC of the Firm

WACC = (Cost of After tax Debt * Weight of Debt) + (Cost of Preferred Stock * Weight of Preferred Stock) + ( Cost of Equity * Weight of Equity)

= (3.40027% * 0.3176) + (20% * 0.0310) + (11.04762% * 0.6514)

= 1.0799% + 0.62% + 7.1964%

= 8.8963% or 8.90%