Organic Produce Corporation has 7.5 million shares of common stock outstanding, 500,000 shares of 7% preferred...

Organic Produce Corporation has 7.5 million shares of common stock outstanding, 500,000 shares of 7% preferred stock outstanding, and 175,000 of 8.2% semiannual bonds outstanding, par value of $1,000 each. The common stock currently sells for $64 per share and has a beta of 1.2, the preferred stock currently sells for $108 per share, and the bonds have 15 years to maturity and sell for 96% of par. The market risk premium is 6.8%, T-Bills are yielding 5.5%, and the firm’s tax rate is 34%.

What is the percentage of each financing option?
What is the WACC of the entire firm?

spreadsheet format is preferred please show all working

Solutions

Expert Solution

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of common stock * cost of common stock)

cost of debt = YTM of bond * (1 - tax rate)

YTM is calculated using RATE function in Excel with these inputs :

nper = 15*2 (15 years to maturity with 2 semiannual coupon payments each year)

pmt = 1000 * 8.2% / 2 (semiannual coupon payment = face value * annual coupon rate / 2. This is a positive figure as it is an inflow to the bondholder)

pv = -1000 * 96% (current bond price = face value * price as a % of par. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

The RATE calculated is the semiannual YTM. To calculate the annual YTM, we multiply by 2. Annual YTM is 8.68%

cost of debt = YTM * (1 - tax rate)

cost of debt = 8.68% * (1 - 34%) ==> 5.73%

cost of preferred stock = dividend / current price = $7 / $108 = 6.48%

cost of equity = risk free rate + (beta * market risk premium)

cost of equity = 5.50% + (1.2 * 6.80%) ==> 13.66%

market value of debt = bonds outstanding * market price per bond

market value of preferred stock = shares outstanding * market price per share

market value of common stock = shares outstanding * market price per share

weight of debt = market value of debt / total market value

weight of debt = 23.93%

weight of preferred stock = market value of preferred stock / total market value

weight of preferred stock = 7.69%

weight of common stock = market value of common stock / total market value

weight of common stock = 68.38%

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of common stock * cost of common stock)

WACC = 11.21%

jeff jeffy answered 1 year ago

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