Question

Given the following information for Michigan Corp. Find the WACC. Assume the tax rate is 35%, bonds are 10,000, 7% coupon bonds outstanding at 1000 parr value with ten years until maturity selling at 105% of the parr, the bond makes semi annual payments. Common shares are 400,000, shares outstanding are selling for $50 a share.

The Beta is 1.15, preferred shares 25,000, shares of 5% preferred stocks outstanding currently selling for $65 a share. Parr value of the preferred is 100, 12% is the expected return of the market and 4 % is the risk free rate.

Assume no floatation cost.

Answer 1

Debt: Number of Bonds = 10000, Coupon Rate = 7 % payable semi-annually, Tenure = 10 years or (10 x 2) = 20 half-years, Par Value = $ 1000, Selling Price = 105 % of Par Value = 1.05 x 1000 = $ 1050

Let the yield to maturity be 2r

Semi-Annual Coupon = 0.07 x 1000 x 0.5 = $ 35

Therefore, 1050 = 35 x (1/r) x [1-{1/(1+r)^(20)}] + 1000 / (1+r)^(20)

Using EXCEL's Goal Seek Function/ a financial calculator/ hit and trial method to solve the above equation, we get:

r = 0.0315896 or 3.15896 %

Cost of Debt = 2 x r = 2 x 3.15896 = 6.31792 %

Debt Value = 1050 x 10000 = $ 10500000

Common Shares: Number of Shares Outstanding = 400000, Price per Share = $ 50

Equity Value = E = 400000 x 50 = $ $ 20000000

Risk-Free Rate = 4% and Return on Market = Rm = 12 %, Beta = 1.15

Cost of Equity = 4 + 1.15 x (12-4) = 13.2 %

Preferred Shares: Number of Preferred Shares Outstanding = 25000, Preferred Stock Price = $ 65

Preferred Stock Value = P = 25000 x 65 = $ 1625000

Preferred Stock Dividend = 5 % of Par Value, Par Value = $ 100

Cost of Preferred Stock = (0.05 x 100) / 65 = 0.07692 or 7.692 %

Tax Rate = 35 %

Total Value = 20000000 + 10500000 + 1625000 = $ 32125000

WACC = (20000000/32125000) x 13.2 + (1625000/32125000) x 7.692 + (10500000/32125000) x 6.31792 x (1-0.35) = 9.94924 % ~ 9.95 %