Question

The charter company has the following financing outstanding. What is the WACC for the company?

Debt: 40,000 bonds with a 8% coupon rate and a current price quote of 1200 the bonds have 25 years to maturity. 150,000 zero coupon bonds with a price quote of 185 and 30 years to maturity.

Preferred Stock: 100,000 shares of 5% preferred stock with a current price of $78, and a par value of $100.

Common Stock: 1,800,000 shares of Common Stock; the current price is $75. And the beta of the stock is 1.2.

Market: The corporate tax rate is 40%, the market risk premium is 7%, and the risk free rate is 4%

Answer 1

Calculation of cost:

i). Cost of coupon bond: PV (current price) = -1,200; FV (par value) = 1,000; PMT (annual coupon) = coupon rate*par value = 8%*1,000 = 80; N (number of coupons) = 25*2 = 50, solve for RATE.

Annual yield = 6.38%

After-tax cost of coupon bond = annual yield*(1-Tax rate) = 6.38%*(1-40%) = 3.83%

ii). Cost of zero coupon bond = [(maturity value/current price)^(1/number of years to maturity)] -1

= [(1,000/185)^(1/30)]-1 = 5.79%

After-tax cost of zero coupon bond = annual yield*(1-Tax rate) = 5.79%*(1-40%) = 3.47%

iii). Cost of preferred stock = annual dividend/current price per share = (dividend rate*par value)/price per share

= (5%*100)/78 = 6.41%

iv). Cost of common stock (using CAPM) = risk-free rate + beta*market risk premium

= 4% + 1.2*7% = 12.40%

Calculation of weight:

i). Market value of coupon bond = number of bonds*current price = 40,000*1,200 = 48,000,000

ii). Market value of zero coupon bond = number of bonds*current price = 150,000*185 = 27,750,000

iii). Market value of preferred stock = number of shares*current price = 100,000*78 = 7,800,000

iv). Market value of common stock = number of shares*current price = 1,800,000*75 = 135,000,000

Total capital = sum of all market values = 48,000,000 + 27,750,000 + 7,800,000 + 135,000,000 = 218,550,000

Weight of coupon bond = market value of coupon bond/total capital = 48,000,000/218,550,000 = 0.2196

Weight of zero coupon bond = market value of zero coupon bond/total capital = 27,750,000/218,550,000 = 0.1270

Weight of preferred stock = market value of preferred stock/total capital = 7,800,000/218,550,000 = 0.0357

Weight of common stock = market value of common stock/total capital = 135,000,000/218,550,000 = 0.6177

WACC calculation:

WACC = sum of (weight*cost of capital)

= (0.2196*3.83%) + (0.1270*3.47%) + (0.0357*6.41%) + (0.6177*12.40%) = 9.17% (Answer)