Question

1. The market value of Aardvark Corp. as of December 31, 2019 was $500 million. The firm’s current capital market structure is on target and is as follows:

Debt:                                       $150 mil

Preferred Stock:                   $55 mil

Common Stock:                    $295 mil

Using data in the Wall St. Journal, the company’s bonds are calculated to have a nominal yield to maturity of 9.25%. The company’s preferred stock sells for $70 per share and pays an annual dividend of $7 per share. The company’s common stock sells for $56 per share and is expected to pay a dividend of $4 per share by the end of this year (i.e. Div₁=$4.00). The dividend is expected to grow at a constant rate of 7% a year. The yield on Treasury Bills is 5.1% while the market risk premium is believed to be 6%. Aardvark is an aggressive stock with a Beta of 1.5.The company’s tax rate is 21%.

To two decimal places, compute the market value weights, each component cost of capital and the Weighted Average Cost of Capital (WACC).     

Answer 1

Bond Yield is 9.25% (Assume it to be Pre-tax)
Dividend on preferred stock is $7
Market price of preferred stock is $70
Market price of common stock is $56
Expected Dividend is $4 (D1)
Growth rate of dividend is 7%
yield on Treasury Bills is 5.1% (Risk free rate of return)
Market risk premium is 6%
Beta of stock is 1.5 times
Tax Rate is 21%
Formula for Cost of capital
Cost of Debt =	Interest rate (1-Tax)
Cost of preferred stock =	Dividend (1+ Growth)
Market value
Cost of Common stock =	Risk free rate of return + Beta(Market risk premium)
(As per CAPM Model)
Particular	Amt (in Mn)	Weights	Cost %	Weight Average
	(a)	(b= a/500*100)	( c )	(d= b*c)
Debt	150	30%	7.31%	2.19%
Preferred Stock	55	11%	10.70%	1.18%
Common Stock	295	59%	14.10%	8.32%
Total	500	100%		11.69%
Thus WACC is 11.69%