Question

Kuhn Co. is considering a new project that will require an initial investment of $4 million. It has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. Kuhn has noncallable bonds outstanding that mature in 15 years with a face value of $1,000, an annual coupon rate of 11%, and a market price of $1555.38. The yield on the company’s current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividend of $9 at a price of $92.25 per share. Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 25%. What will be the WACC for this project? (Note: Round your intermediate calculations to two decimal places.)

Answer 1

Calculation of WACC

WACC = Cost of Debt * % Debt ( 1 - Tax rate) + Cost of Equity * % Equity + Cost of Prefereed stock * % of Preferred stock

Lets Calculate Each of the three :

Debt Portion :

% of debt = 45 %

cost of debt :

given data N= 15 FV = $1000 Price = $1555.38 Lets calculate the bond yeild using financial calculator I/Y = 5.48%

Since the yield on the company’s current bonds is a good approximation of the yield on any new bonds that it issues cost of sebt is assumed to be 5.48 % and given tax rate = 25%

Preferred shares :

% Preferred shares = 4%

cost of preferred shares : Dividend = $9 Price of preffered share = $ 92.25 D/P = 9/92.25 = 9.76%

Common Equity :

% of common Equity = 51%

Stock Price = $33.35 per share, expected dividend of $2.78 at the end of next year.

Flotation costs = 8% constant growth rate = 9.2%

Cost of New Equity =	D1	+ g
P0 × (1 − F)

Where,
D1 is dividend in next period
P0 is the issue price of a share of stock
F is the ratio of flotation cost to the issue price
g is the dividend growth rate.

Cost of New Equity : [2.78 / 33.35 ( 1 - 0.08)] + 0.092 = 18. 26 %

Now Plugging all the values in the above formula:

WACC = 0.45 * 0.0548 * (1 - 0.25 ) + 0.04 * 0.0976 + 0.51 * 0.1826

WACC = 11.55%