Question

26) ABC Inc. has 10 million shares of common stock outstanding. The firm also has1,200,000 shares of 6 percent preferred stock (annual dividend=$6) and 300,000 semi-annual bonds of $1,000 face value with a coupon rate of 8 percent semiannual bonds outstanding. The bonds were issued five years ago with maturity of 30 years when they were issued. The market price of common stock is $46 per share and has a beta of 0.85, the preferred stock currently sells for $90 per share, and the bonds sell for 108 percent of par. The market risk premium is 7.5 percent and T-bills yield 4 percent. The firm pays taxes at21 percent. What is the WACC for the firm?

Please show the calculations. Thank you in advance :)

Answer 1

Debt:

Number of bonds outstanding = 300,000
Face Value = $1,000
Current Price = 108%*$1,000 = $1,080

Value of Debt = 300,000 * $1,080
Value of Debt = $324,000,000

Annual Coupon Rate = 8%
Semiannual Coupon Rate = 4%
Semiannual Coupon = 4%*$1,000 = $40

Time to Maturity = 25 years
Semiannual Period to Maturity = 50

Let semiannual YTM be i%

$1,080 = $40 * PVIFA(i%, 50) + $1,000 * PVIF(i%, 50)

Using financial calculator:
N = 50
PV = -1080
PMT = 40
FV = 1000

I = 3.65%

Semiannual YTM = 3.65%
Annual YTM = 2 * 3.65%
Annual YTM = 7.3%

Before-tax Cost of Debt = 7.3%
After-tax Cost of Debt = 7.3% * (1 - 0.21)
After-tax Cost of Debt = 5.77%

Preferred Stock:

Number of shares outstanding = 1,200,000
Current Price = $90
Annual Dividend = $6

Value of Preferred Stock = 1,200,000 * $90
Value of Preferred Stock = $108,000,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $6 / $90
Cost of Preferred Stock = 6.67%

Equity:

Number of shares outstanding = 10,000,000
Current Price = $46

Value of Common Stock = 10,000,000 * $46
Value of Common Stock = $460,000,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 4% + 0.85 * 7.5%
Cost of Common Equity = 10.38%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $324,000,000 + $108,000,000 + $460,000,000
Value of Firm = $892,000,000

Weight of Debt = $324,000,000/$892,000,000
Weight of Debt = 0.3632

Weight of Preferred Stock = $108,000,000/$892,000,000
Weight of Preferred Stock = 0.1211

Weight of Common Stock = $460,000,000/$892,000,000
Weight of Common Stock = 0.5157

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 = 0.3632*5.77% + 0.1211*6.67% + 0.5157*10.38%
WACC = 8.26%