Question

Consider the case of Kuhn Corporation. Kuhn Corporation is considering a new project that will require an initial investment of $45,000,000. It has a target capital structure consisting of 45% debt, 4% preferred stock, and 51% common equity. Kuhn has noncallable bonds outstanding that mature in 15 years with a face value of $1,000, an annual coupon rate of 11%, and a market price of $1,555.38. 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 $8.00 at a price of $95.70 per share. Kuhn Corporation 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 $1.36 at the end of next year. Flotation costs will represent 3.00% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 8.70%, and they face a tax rate of 40%. Kuhn Company's WACC for this project will be

Answer 1

Weight of equity = E/A

Weight of equity =

W(E)=0.51

Weight of debt = D/A

Weight of debt = 0.45

W(D)=0.45

Weight of preferred equity =1-D/A-E/A

Weight of preferred equity = =1-0.45 - 0.51

W(PE)=0.04

Cost of equity

As per DDM

Price(1-flotation %)= Dividend in 1 year/(cost of equity - growth rate)

33.35*(1-0.03) = 1.36/ (Cost of equity - 0.087)

Cost of equity% = 12.9

Cost of debt

K = N

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

k=1

K =15

1555.38 =∑ [(11*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^15

k=1

YTM = 5.4758647564

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

After tax cost of debt = 5.4758647564*(1-0.4)

= 3.28551885384

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 8/(95.7)*100

=8.36

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

WACC=3.29*0.45+12.9*0.51+8.36*0.04

WACC =8.39%