Question

ABC firm is selling bonds for​ $950 a bond with​ $1,000 par value at​ 5% coupon paid annually. The bond will mature in 8 years. Firm is selling​ 10,000 such bonds. This firm is also selling preferred stock at​ $75 per share. Firm is selling​ 100,000 such shares at​ 8% dividend with​ $100 par value. This firm is also raising money by selling another issue of common stocks. The most recent dividend was​ $4.50 and this firm is expecting to grow at​ 7% rate per year forever. The current selling price of their stock is​ $60 and company is planning to sell​ 300,000 shares. Estimate Weighted Average Cost of Capital​ (WACC). This firm is in​ 40% tax bracket.

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=60*300000

=18000000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*10000*0.95

=9500000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=75*100000

=7500000

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=18000000+9500000+7500000

=35000000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 18000000/35000000

W(E)=0.5143

Weight of debt = MV of Bond/MV of firm

Weight of debt = 9500000/35000000

W(D)=0.2714

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 7500000/35000000

W(PE)=0.2143

Cost of equity

As per DDM

Price = recent dividend* (1 + growth rate )/(cost of equity - growth rate)

60 = 4.5 * (1+0.07) / (Cost of equity - 0.07)

Cost of equity% = 15.03

Cost of debt

K = N

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

k=1

K =8

950 =∑ [(5*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^8

k=1

YTM = 11.268

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

After tax cost of debt = 11.268*(1-0.4)

= 6.7608

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 8/75*100

=10.67

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

WACC=6.76*0.2714+15.03*0.5143+10.67*0.2143

WACC =11.85%