Question

Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 58% debt, If its current tax rate is 40%, how much higher will 6% preferred stock, and 36% common equity. It has a Turnbull's weighted average cost of capital (WACC) be if before-tax cost of debt of 11.1%, and its cost of it has to raise additional common equity capital by preferred stock is 12.2%. issuing new common stock instead of raising the funds through retained earnings? If Turnbull can raise all of its equity capital from retained 0.83% earnings, its cost of common equity will be 14.7%. 0.94% However, if it is necessary to raise new common equity, 0.75% it will carry a cost of 16.8%. 0.90% Turnbull Co. is considering a project that requires an initial investment of $570,000. The firm will raise the $570,000 in capital by issuing $230,000 of debt at a before-tax cost of 8.7%, $20,000 of preferred stock at a cost of 9.9%, and $320,000 of equity at a cost of 13.2%. The firm faces a tax rate of 40%. What will be the WACC for this project? 9.86% Consider the case of Kuhn Co. Kuhn Co. is considering a new project that will require an initial investment of $20 million. It has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. Kuhn has noncallable bonds outstanding that mature in five years with a face value of $1,000, an annual coupon rate of 10%, and a market price of $1,050.76. The yield on the company's current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividend of $8 at a price of $95.70 per share. You can assume that Jordan does not incur any flotation costs when issuing debt and preferred stock. Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 3% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 40%. Determine what Kuhn Company's WACC will be for this project. 9.43% 11.42% 10.43% 9.93% Elach Davor WITN 27 0 0 202

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Answer 1

Sol. Kuhn Co. WACC =[costequity X wta equity +[cost 9 debt x %3D wr n Debt ] + [cost q Pry sh x ut a prf sh 36Y. (given) * 58Y. (given (giren) wt. n eamity wt.of debt wt on frefened stack 67% = DI Cost n equity ex(1-f) Dividend on wnt Price n shave Di year %3D ratio 1 Hootion cost %3D growth rote %3D 0.092 2.78 So, cost 1 equity 3.35 (1-0.03) O.1779 or 17.79% letex(-tox) Cost 7 Interst xpeasa Debt %3D for dabt, lets clculate YTM first. YTM 2.

coupon Intenest payment to motuity - ho, o7 years focL Volue Price 1000 -1050.76 YTM %3D lo50.76 I o0o + = 0.0876 8.76 Y. or 8.76Y.(1-40Y) = 5.25% Cost a subt = Profened stack = 0.0836 or 8.36Y. Cost 95.7 WACC =[n.19 x 36Y.] + [s.25%. X 59] + [8.36Y XCY.] %3D = 9.93% (apptox).