Question

A company has found that its common equity capital shares have a beta equal to 1.5 while the risk-free return is 8 % and the expected return on the market is 14 %.
It has 7-year semiannual maturity bonds outstanding with a price of $767.03 that have a coupon rate of 7 %.
It has preferred stock that sells for $25 and pays a dividend of $4.
The firm is financed with $120,000,000 of common shares (market value), $45,000,000 of preferred stock, and $80,000,000 of debt.
What is its after-tax cost of capital, if it is subject to a 35 % marginal tax rate?

Step 1: find weights for debt, preferrred, and common.
Step 2: find the costs of debt, preferred, and common.
Step 3: find wacc
Show your work and highligth your answer.
Use excel for calculations.

Answer 1

1

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

=120000000+80000000+45000000

=245000000

Weight of Equity = Value of Equity/Total Capital Value

= 120000000/245000000

=0.4898

Weight of Debt = Value of Debt/Total Capital Value

= 80000000/245000000

=0.3265

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

= 45000000/245000000

=0.1837

2

Cost of equity

As per CAPM

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

Cost of equity% = 8 + 1.5 * (14 - 8)

Cost of equity% = 17

Cost of debt

K = Nx2

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

k=1

K =7x2

767.03 =∑ [(7*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^7x2

k=1

YTM = 12.0151650883

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

After tax cost of debt = 12.0151650883*(1-0.35)

= 7.809857307395

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 4/25*100

=16

3

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

WACC=7.81*0.3265+17*0.4898+16*0.1837

WACC =13.82%