Question

Caspian Sea Drinks' is financed with 70.00% equity and the remainder in debt. They have 12.00-year, semi-annual pay, 5.27% coupon bonds which sell for 98.50% of par. Their stock currently has a market value of $24.14 and Mr. Bensen believes the market estimates that dividends will grow at 3.26% forever. Next year’s dividend is projected to be $2.29. Assuming a marginal tax rate of 29.00%, what is their WACC (weighted average cost of capital)?

Answer 1

Weight of equity = 1-D/A

Weight of equity = 1-0.3

W(E)=0.7

Weight of debt = D/A

Weight of debt = 0.3

W(D)=0.3

Cost of equity

As per DDM

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

24.14 = 2.29/ (Cost of equity - 0.0326)

Cost of equity% = 12.75

Cost of debt

K = Nx2

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

k=1

K =12x2

985 =∑ [(5.27*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^12x2

k=1

YTM = 5.4418596104

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

After tax cost of debt = 5.4418596104*(1-0.29)

= 3.863720323384

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

WACC=3.86*0.3+12.75*0.7

WACC =10.08%