Question

MABK Sdn Bhd has a target capital structure that consists of 60% common equity and 40% debt. In order to calculate MABK weighted average cost of capital, an analyst has accumulated the following information: The company’s bond will mature in 12 years; carry a coupon rate of 7.5% with interest to be paid semi-annually. The bonds have a face value of $1,000 and selling for $1,010.00 per unit. The company uses the CAPM to calculate the cost of common stock. The risk-free rate is 5% and market risk premium is 6%. The beta on common stock is 1.15. The company’s retained earnings are sufficient so that they do not have to issue any new common stock to fund capital projects. The company’s tax rate is 30%. Given this information

what is MABK weighted average cost of capital?

Answer 1

First, we will find the after-tax cost of the company's bond

by using the formula to find the present value /price of the bond,ie.

PV/Price of the bond=PV of all its future coupons+PV of Face value at it smaturity (both discounted at its yield)

ie. PV/Price=(Pmt.*(1-(1+r)^-n)/r)+(FV/(1+r)^n)

where, PV/Price is given as $ 1010 /bond

Pmt.= the semi-annual $ coupon amt, ie.1000*7.5%/2= $ 37.5

r=the before-tax semi-annual cost/yield to maturity--to be found out----??

n=no.of semi-annual coupons still pending to maturity, ie.12 yrs.*2=24

FV=Face value, ie. $ 1000

Now, plugging all the values, in the formula,

ie. 1010=(37.5*(1-(1+r)^-24)/r)+(1000/(1+r)^24)

& solving for r,

we get the before-tax semi-annual cost/yield as

3.6865%

Now, the annual before-tax cost=

(1+3.6865%)^2-1=

7.5089%

The annual after-tax cost of the bond=

Before-tax cost*(1-Tax rate)

ie.7.5089%*(1-30%)=

5.26%

Cost of Retained earnings,

as per CAPM,

k re=RFR+(Beta*Market risk premium)

ie.5%+(1.15*6%)=

11.90%

MABK weighted average cost of capital, WACC=

(Wt.re*k re)+(Wt.d*kd)

ie.(60%*11.90%)+(40%*5.26%)=

9.24%

(Answer)