Question

Caspian Sea Drinks' is financed with 69.00% equity and the remainder in debt. They have 12.00-year, semi-annual pay, 5.42% coupon bonds which sell for 98.37% of par. Their stock currently has a market value of $25.81 and Mr. Bensen believes the market estimates that dividends will grow at 3.16% forever. Next year’s dividend is projected to be $2.29. Assuming a marginal tax rate of 22.00%, what is their WACC (weighted average cost of capital)? Answer Format: Percentage Round to: 2 decimal places (Example: 9.24%, % sign required. Will accept decimal format rounded to 4 decimal places (ex: 0.0924))

Answer 1

As per DDM

Price = Dividend in 1 year/(cost of equity - growth rate)

25.81 = 2.29/ (Cost of equity - 0.0316)

Cost of equity% = 12.03

K = Nx2

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

k=1

K =12x2

983.7 =∑ [(5.42*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^12x2

k=1

YTM% = 5.61 = cost of debt

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

After tax cost of debt = 5.61*(1-0.22)

= 4.3758

Weight of equity = 1-D/A

Weight of equity = 1-0.31

W(E)=0.69

Weight of debt = D/A

Weight of debt = 0.31

W(D)=0.31

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

WACC=4.38*0.31+12.03*0.69

WACC% = 9.66