In: Finance
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%.
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%