Question

You have been given the task of calculating the WACC of ABC Inc. You will use the following information to calculate the WACC. The firm has 3000 coupon paying bonds outstanding. Each coupon-paying bond has a face value of $1000, will mature 10 years from today, and is currently priced at 130% of the face value. The annual coupon rate is 12%, and coupon is paid on an annual basis. The company has 500,000 common shares outstanding, and each share is currently trading at $12. You have decided to use CAPM to calculate the cost of equity. The risk-free rate is 5%, and the market risk premium is 5%. The equity beta of the company is 2. Also, the company has 200,000 preferred shares. Each share is trading at $10, and the constant yearly preferred dividend per share is $1.2. Finally, the company faces a tax rate of 30%. (Please show your work)

Answer 1

Debt:

Number of bonds outstanding = 3,000
Face Value = $1,000

Current Price = 130% * $1,000
Current Price = $1,300

Market Value of Debt = 3,000 * $1,300
Market Value of Debt = $3,900,000

Annual Coupon Rate = 12.00%
Annual Coupon = 12.00% * $1,000
Annual Coupon = $120

Time to Maturity = 10 years

Let Annual YTM be i%

$1,300 = $120 * PVIFA(i%, 10) + $1,000 * PVIF(i%, 10)

Using financial calculator:
N = 10
PV = -1300
PMT = 120
FV = 1000

I = 7.608%

Annual YTM = 7.608%

Before-tax Cost of Debt = 7.608%
After-tax Cost of Debt = 7.608% * (1 - 0.30)
After-tax Cost of Debt = 5.326%

Preferred Stock:

Number of shares outstanding = 200,000
Current Price = $10

Market Value of Preferred Stock = 200,000 * $10
Market Value of Preferred Stock = $2,000,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $1.20 / $10
Cost of Preferred Stock = 0.12 or 12.000%

Common Stock:

Number of shares outstanding = 500,000
Current Price = $12

Market Value of Common Stock = 500,000 * $12
Market Value of Common Stock = $6,000,000

Cost of Common Stock = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Stock = 5.00% + 2.00 * 5.00%
Cost of Common Stock = 15.000%

Market Value of Firm = Market Value of Debt + Market Value of Preferred Stock + Market Value of Common Stock
Market Value of Firm = $3,900,000 + $2,000,000 + $6,000,000
Market Value of Firm = $11,900,000

Weight of Debt = $3,900,000 / $11,900,000
Weight of Debt = 0.3277

Weight of Preferred Stock = $2,000,000 / $11,900,000
Weight of Preferred Stock = 0.1681

Weight of Common Stock = $6,000,000 / $11,900,000
Weight of Common Stock = 0.5042

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Preferred Stock * Cost of Preferred Stock + Weight of Common Stock * Cost of Common Stock
WACC = 0.3277 * 5.326% + 0.1681 * 12.000% + 0.5042 * 15.000%
WACC = 11.33%