Question

MECAB is a large, publicly traded firm that is the market share leader in Electric Cables manufacturing and distribution. The current market data on MECAB securities is as follows:

Debt:					130,000 7 percent coupon bonds outstanding, 15 years to maturity, selling for 94 percent of par; with a $100 par value and making semiannual payments.
Common stock:					6,000,000 shares outstanding, selling for 52 per share; the beta is 1.2.
Preferred stock:					300,000 shares of preferred stock outstanding, paying a dividend of 7.35 and selling for 90 per share.
Market:					7 percent expected market risk premium; 4 percent risk-free rate.
MECAB’s tax rate is 35 percent.
	1.		What are the market values of the individual capital components?
	2.		What are MECAB’s capital structure weights?
	3.		What is the cost of common stock?
	4.		What is the cost of preferred stock?
	5.		What is the cost of debt?
	6.		What is the weighted average cost of capital?

Answer 1

1). market value = number of securities*current market price

market value of debt = 130,000*94 = 12,220,000

market value of common stock = 6,000,000*52 = 312,000,000

market value of preferred stock = 300,000*90 = 27,000,000

2). capital structure weight = market value of security/total market value

Total market value = 12,220,000 + 312,000,000 + 27,000,000 = 351,220,000

weight of debt = 12,220,000/351,220,000 = 3.48%

weight of common stock = 312,000,000/351,220,000 = 88.83%

weight of preferred stock = 27,000,000/351,220,000 = 7.69%

3). Cost of common stock = risk-free rate + beta*market risk premium = 4% + (1.2*7%) = 12.40%

4). Cost of preferred stock = annual dividend/current price = 7.35/90 = 8.167%

5). Cost of debt: FV = 100; PV = 94; PMT (semi-annual coupon) = coupon rate*par value/2 = 7%*100/2 = 3.5; N (number of payments) = 15*2 = 30, solve for RATE.

Semi-annual YTM = 3.84%, so annual YTM = 3.84%*2 = 7.68%

After-tax cost of debt = 7.68%*(1-35%) = 4.99%

6). Weighted average cost of capital = sum of weighted capital

WACC = 11.817%