(WACC) A company has common stock, preferred shares, and debt outstanding. As of today, the common...

(WACC) A company has common stock, preferred shares, and debt outstanding. As of today, the common stock is valued at $10 per share, with 2 million shares outstanding. It has a beta of 5, and market return is estimated to be 4% while treasury bills offer 1.5% risk-free rate. The preferred stock is valued at $15 per share, which pays dividend of $2 each year at a constant growth rate of 3%. Preferred stocks have 5 million shares outstanding. Finally, debt has a market value of $4 million dollars and pays an interest rate of 5%. Tax rate is 40%. Calculate WACC.

Show formula and work using hand-only. Do not use excel.

Solutions

Expert Solution

We would calculate the cost for each of the finance obtained.

Formula to calculate cost of equity using CAPM model
Ke = Rf + Beta*(Rm-Rf)
where Ke = cost of equity
Rf = risk free rate
Rm = market interest rate

Calculation of cost of equity
Ke = 0.015 + 5*(0.04-0.015)
Ke = 0.015 + 0.125
Ke = 0.015 + 0.125
Ke = 14%

The cost of equity is 14%

Formula to calculate cost of preferred stock
Kp = (D0*(1+g)/P) + g
where Kp = Cost of preference shares
D0 is the dividend paid
g = growth rate
P = price of preferred stock
Calculation of cost of preferred stock
Kp = (2*(1.03))/15 + 0.03
Kp = 2.06/15 + 0.03
Kp = 0.1373 + 0.03
Kp = 16.73%

The cost of preference share is 16.73%

Formula to calculate after tax cost of debt
After tax cost of debt = Interest rate*(1-t)
Calculation of after tax cost of debt
After tax cost of debt = 0.05*(1-0.40)
After tax cost of debt = 3%
The after tax cost of debt is 3%

Calculation of Weights of each financing option
	Value	Weights
Equity (2000000*10)	$20,000,000	20.20%	2000000/99000000
Preference share (5000000*15)	$75,000,000	75.76%	7500000/99000000
Debt	$4,000,000	4.04%	4000000/99000000
Total finance	$99,000,000	100.00%

Formula to calculate WACC
WACC = WeKe + WpKp + Wd*Kd
where We = weight of equity
Ke = Cost of equity
Wp = weight of preferred stock
Kp = cost of preferred stock
Wd = weight of debt
Kd = cost of debt

Calculation of WACC
WACC = (0.20200.14)+(0.75760.1673)+(0.0404*0.03)
WACC = 15.63%

The WACC of the company is 15.63%

jeff jeffy answered 1 year ago

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