Question

FIND THE WACC WITH THE GIVEN INFORMATION

• 8% Bonds with remaining maturity of 10 years currently selling in the market for $112.75. # of Bonds Outstanding = 5 million (bond prices in the bond market are quoted in % of 1,000)
• 7% preferred stock currently selling in the market for $115. # of preferred stocks outstanding = 10 million
• Common stock has current market price of $60.20. # of common stock outstanding = 75 million. Risk free rate of return = 5% (krf).  Overall market return = 12% (km). Firm’s beta coefficient = 1.20.
• Marginal tax bracket = 21%

HINT – using CAPM model to find investor’s required return (ks)

Answer 1

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

MV of equity=60.2*75000000

=4515000000

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

MV of Bond=1000*5000000*1.11275

=5563750000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=115*10000000

=1150000000

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

=4515000000+5563750000+1150000000

=11228750000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 4515000000/11228750000

W(E)=0.4021

Weight of debt = MV of Bond/MV of firm

Weight of debt = 5563750000/11228750000

W(D)=0.4955

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

Weight of preferred equity = 1150000000/11228750000

W(PE)=0.1024

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (expected return on the market - risk-free rate)

Cost of equity% = 5 + 1.2 * (12 - 5)

Cost of equity% = 13.4

Cost of debt

K = N

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

k=1

K =10

1112.75 =∑ [(8*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^10

k=1

YTM = 6.4362689707

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

After tax cost of debt = 6.4362689707*(1-0.21)

= 5.084652486853

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 7/115*100

=6.09

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

WACC=5.08*0.4955+13.4*0.4021+6.09*0.1024

WACC =8.53%