Question

1.GE has 20,000 bonds outstanding with a 7% coupon rate, paid semiannual. There are 20 years left to maturity and have a market price of 990.00 (face value 1000). The company also has 700,000 shares outstanding and currently sell at $32 a share. GE has a beta of 1.09. You expect the market risk premium to be 9% and the risk free rate is currently 2%. Ge also has 200,000 shares of preferred stock which pays an annual dividend of $5. The preferred stock is currently trading at $29 a share. Assuming a 21% tax rate, what is the WACC?

2. You need to raise one billion dollar for a new project. JP Morgan states that they will charge you a 7.5% flotation fee on equity, and a 4.5% flotation fee on debt. If you don’t want to alter the company’s capital structure, which is currently a Debt-to-Equity Ratio of 0.5, how much do you need to raise so that you can fund your project?

Answer 1

Answer 1:

Cost of debt:

Face value of bond = $1000

Market price = $990

Semiannual coupon = 1000 * 7%/2 = $35

Time to maturity = 20 years = 40 semiannual periods

To get yield we use RATE function of excel:

= RATE (nper, pmt, pv, fv, type)

= RATE (40, 35, -990, 1000, 0)

= 3.5472%

Yearly yield = 3.5472% * 2 = 7.0943%

Cost of equity:

Cost of equity = Risk free rate + Beta * Market risk premium

= 2% + 1.09 * 9%

= 11.81%

Cost of Preferred stock:

Cost of preferred stock = annual dividend / Current price = 5 / 29 = 17.2414%

Capital structure:

Market value of bonds = 20000 * 990 = $19,800,000

Market value of equity = 700000 * 32 = $22,400,000

Market value of preferred stock = 200000 * 29 = $5,800,000

Total value = 19800000 + 22400000 + 5800000 = $48,000,000

WACC:

WACC = Cost of equity * weight of equity + Cost of debt * (1 - tax rate) * weight of debt + Cost of pref stock * weight of pref. stock

= 11.81% * 22400000 /48000000 + 7.0943% * (1 - 21%) * 19800000 / 48000000 + 17.2414% * 5800000 / 48000000

= 9.91%

WACC = 9.91%

Answer 2:

Capital required to be raised = $1 billion = $1000,000,000

Debt-to-Equity Ratio of 0.5

Amount of Debt required = 1000,000,000 * 0.5 / (1 + 0.5) = $333,333,333.33

Amount of Equity required = 1000,000,000 * 1 / (1 + 0.5) = $666,666,666.67

Charges:

7.5% flotation fee on equity

4.5% flotation fee on debt

Hence:

Equity to be raised = Amount required / (1 - flotation fees %) = 666,666,666.67 / (1 - 7.5%) = $720,720,720.72

Debt to raised = Amount required /(1 - flotation fees %) =  333333333.33 / (1 - 4.5%) = $349,040,139.62

Equity to be raised = $720,720,720.72

Debt to raised = $349,040,139.62