Question

You are looking at the following information:

  

Debt:		2,500 8.5 percent coupon bonds outstanding, $1,000 par value, 21 years to maturity, selling for 104 percent of par; the bonds make semiannual payments.
Common stock:		62,500 shares outstanding, selling for $61 per share; the beta is 1.1.
Preferred stock:		8,000 shares of 7 percent preferred stock (review my Ch.8 slide 43: what does "...% preferred stock" phrase mean?) outstanding, currently selling for $106 per share.
Market:		10 percent market risk premium and 6.5 percent risk-free rate.

  

The company is in the 31 percent tax rate bracket based on its corporate income.

  

Required:

  

Find the WACC. (Do not round your intermediate calculations.)

rev: 09_20_2012

Multiple Choice

• 12.36%

• 11.96%

• 12.86%

• 12.13%

• 11.86%

Next Visit question map

Question4of10Total4 of 10

Prev

Answer 1

Debt:

Number of bonds outstanding = 2,500
Face Value = $1,000
Current Price = 104%*$1,000 = $1,040

Value of Debt = 2,500 * $1,040
Value of Debt = $2,600,000

Annual Coupon Rate = 8.50%
Semiannual Coupon Rate = 4.25%
Semiannual Coupon = 4.25%*$1,000 = $42.50

Time to Maturity = 21 years
Semiannual Period to Maturity = 42

Let semiannual YTM be i%

$1,040 = $42.50 * PVIFA(i%, 42) + $1,000 * PVIF(i%, 42)

Using financial calculator:
N = 42
PV = -1040
PMT = 42.50
FV = 1000

I = 4.05%

Semiannual YTM = 4.05%
Annual YTM = 2 * 4.05%
Annual YTM = 8.10%

Before-tax Cost of Debt = 8.10%
After-tax Cost of Debt = 8.10% * (1 - 0.31)
After-tax Cost of Debt = 5.589%

Preferred Stock:

Number of shares outstanding = 8,000
Current Price = $106
Annual Dividend = 7%*$100 = $7

Value of Preferred Stock = 8,000 * $106
Value of Preferred Stock = $848,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $7 / $106
Cost of Preferred Stock = 6.604%

Equity:

Number of shares outstanding = 62,500
Current Price = $61

Value of Common Stock = 62,500 * $61
Value of Common Stock = $3,812,500

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 6.50% + 1.1 * 10.00%
Cost of Common Equity = 17.50%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $2,600,000 + $848,000 + $3,812,500
Value of Firm = $7,260,500

Weight of Debt = $2,600,000 / $7,260,500
Weight of Debt = 0.3581

Weight of Preferred Stock = $848,000 / $7,260,500
Weight of Preferred Stock = 0.1168

Weight of Common Stock = $3,812,500 / $7,260,500
Weight of Common Stock = 0.5251

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Preferred Stock * Cost of Preferred Stock + Weight of Common Stock * Cost of Common Stock
WACC = 0.3581 * 5.589% + 0.1168 * 6.604% + 0.5251 * 17.500%
WACC = 11.96%