Question

Maschale Corp. wants to issue bonds with a zero coupon bond, a face value of $1,000, and 12 years to maturity. Maschale
estimates that the bonds will sell for $384. Maschale Corp. common stock currently sells for $30 per share. Maschale paid
a dividend yesterday of $4.00 per share and expects the dividend to grow at a constant rate of 5% per year. Maschaleʹs
capital structure is $4 million debt, $6 million common equity and $5 million preferred stock which pays $3.2 dividend and
selling at $40 per share. Maschaleʹs marginal tax rate is 35%.

a. Calculate the after-tax cost of debt assuming Maschaleʹs bonds are its only debt.
b. Calculate the cost of preferred stock.
c. Calculate the cost of common equity.
d. Calculate the weighted average cost of capital

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

2) Milton Parker has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of
common equity, based upon current market values. Parkerʹs yield to maturity on its bonds is 7.4%, and investors require
an 8% return on Parkerʹs preferred and a 14% return on Parkerʹs common stock. If the tax rate is 35%, what is Parkerʹs
WACC? 2) _______
A) 12.25% B) 10.18% C) 8.12% D) 7.21%

Answer 1

1

a

Cost of debt

K = N

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

k=1

K =12

384 =∑ [(0*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^12

k=1

YTM = 8.3026453522

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

After tax cost of debt = 8.3026453522*(1-0.35)

= 5.39671947893

b

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 3.2/40*100

=8

c

As per DDM

Price = recent dividend* (1 + growth rate )/(cost of equity - growth rate)

30 = 4 * (1+0.05) / (Cost of equity - 0.05)

Cost of equity% = 19

d

Total Asset value = Value of Debt + Value of Equity + Value of Preferred equity

=4+6+5

=15

Weight of Debt = Value of Debt/Total Asset Value

= 4/15

=0.2667

Weight of Equity = Value of Equity/Total Asset Value

= 6/15

=0.4

Weight of Preferred equity = Value of Preferred equity/Total Asset Value

= 5/15

=0.3333

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

WACC=5.4*0.2667+19*0.4+8*0.3333

WACC% = 11.71

2

Total Asset value = Value of Debt + Value of Equity + Value of Preferred equity

=7+11+2

=20

Weight of Debt = Value of Debt/Total Asset Value

= 7/20

=0.35

Weight of Equity = Value of Equity/Total Asset Value

= 11/20

=0.55

Weight of Preferred equity = Value of Preferred equity/Total Asset Value

= 2/20

=0.1

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

After tax cost of debt = 7.4*(1-0.35)

= 4.81

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

WACC=4.81*0.35+14*0.55+8*0.1

WACC% = 10.18