Question

The Saunders Investment Bank has the following financing outstanding.

Debt:	50,000 bonds with a coupon rate of 7 percent and a current price quote of 110; the bonds have 20 years to maturity. 220,000 zero coupon bonds with a price quote of 18 and 30 years until maturity. Both bonds have a par value of $1,000. Assume semiannual compounding.
Preferred stock:	140,000 shares of 5 percent preferred stock with a current price of $80, and a par value of $100.
Common stock:	2,500,000 shares of common stock; the current price is $66, and the beta of the stock is 1.2.
Market:	The corporate tax rate is 35 percent, the market risk premium is 6 percent, and the risk-free rate is 3 percent.

What is the WACC for the company? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

WACC            %

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=66*2500000

=165000000

MV of Bond1=Par value*bonds outstanding*%age of par

MV of Bond1=1000*50000*1.1

=55000000

MV of Bond2=Par value*bonds outstanding*%age of par

MV of Bond2=1000*220000*0.18

=39600000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=80*140000

=11200000

MV of firm = MV of Equity + MV of Bond1+ MV of Bond 2+ MV of Preferred equity

=165000000+55000000+39600000+11200000 =

=270800000

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 3 + 1.2 * (6)

Cost of equity% = 10.2

Cost of debt

Bond1

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =20x2

1100 =∑ [(7*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^20x2

k=1

YTM1 = 6.13

Bond2

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =30x2

180 =∑ [(0*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^30x2

k=1

YTM2 = 5.8

Firm cost of debt=YTM1*(MV bond1)/(MV bond1+MV bond2)+YTM2*(MV bond2)/(MV bond1+MV bond2)

Firm cost of debt=6.13*(55000000)/(55000000+39600000)+5.8*(55000000)/(55000000+39600000)

Firm cost of debt=5.99%

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

After tax cost of debt = 5.99*(1-0.35)

= 3.8935

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 5/80*100

=6.25

Weight of equity = MV of Equity/MV of firm

Weight of equity = 165000000/270800000

W(E)=0.6093

Weight of debt = MV of Bond/MV of firm

Weight of debt = 94600000/270800000

W(D)=0.3493

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 11200000/270800000

W(PE)=0.0414

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=3.89*0.3493+10.2*0.6093+6.25*0.0414

WACC% = 7.83