Question

Let’s put it all together in an example: Hermione Corp. has 400,000 shares of common stock outstanding, trading at $52.85 per share. They have 90,000 shares of preferred stock trading at $74.14 per share, and $15,000,000 (face value) in debt, with 8 years to maturity, a 9% coupon, and a YTM of 8%. The firm has a beta of 1.97, the risk-free rate is 2.5% and the expected market return is 12%. Their last preferred dividend was $9.25 per share. Their tax rate is 36%. What is Hermione Corp’s WACC?

Specific step solution,please.

Answer 1

K = N

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

k=1

K =8

Bond Price =∑ [(9*1000/100)/(1 + 8/100)^k]     +   1000/(1 + 8/100)^8

k=1

Bond Price = 1057.47

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

MV of equity=52.85*400000

=21140000

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

MV of Bond=1000*15000*1.05747

=15862050

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=74.14*90000

=6672600

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

=21140000+15862050+6672600

=43674650

Weight of equity = MV of Equity/MV of firm

Weight of equity = 21140000/43674650

W(E)=0.484

Weight of debt = MV of Bond/MV of firm

Weight of debt = 15862050/43674650

W(D)=0.3632

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

Weight of preferred equity = 6672600/43674650

W(PE)=0.1528

Cost of equity

As per CAPM

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

Cost of equity% = 2.5 + 1.97 * (12 - 2.5)

Cost of equity% = 21.22

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

After tax cost of debt = 8*(1-0.36)

= 5.12

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 9.25/74.14*100

=12.48

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

WACC=5.12*0.3632+21.22*0.484+12.48*0.1528

WACC =14.04%