Question

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 11.1%, $20,000 of preferred stock at a cost of 12.2%, and $320,000 of equity at a cost of 14.7%. The firm faces a tax rate of 40%. What will be the WACC for this project? 11.36%    (Note: Round your intermediate calculations to three decimal places.)

Consider the case of Kuhn Co.

Kuhn Co. is considering a new project that will require an initial investment of $45 million. It has a target capital structure of 35% debt, 2% preferred stock, and 63% 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 $92.25 per share.

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 $22.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 8.7%, and they face a tax rate of 40%. What will be the WACC for this project?      (Note: Round your intermediate calculations to two decimal places.)

Answer 1

А В C 1 2 Initial Investment $570,000 4 Weight of 5 Debt 40.35% 6 Preferred Stock 3.51% 7 Common Stock 56.14% 9 Cost of 10 Debt 11.10% 11 Preferred Stock 12.20% 12 Common Stock 14.70% 13 14 Tax Rate 40% 15 16 WACC 11.368% 17

В 1 2 Initial Investment 570000 3 4 Weight of 5 Debt 6 Preferred Stock 7 Common Stock -230000/$B$2 -20000/B2 320000/B2 8 9 Cost of 10 Debt 0.111 11 Preferred Stock 12 Common Stock 0.122 0.147 13 14 Tax Rate 0.4 15 (B5*B10*(1-B14))+(B6* B11)+(B7* B12) 16 WACC 17 18

A В C D E F G 1 Cost of Common Equity 2 Cost of Debt We need to calculate YTM for this bond We need to use constant growth dividend discount 3 D1 + g r = issue, which is cost of debt model for this PO 5 Par Value 6 Coupon Rate 7 Market price Price of Common Stock 1000 22.35 10% Floatation Cost 8% Price Net of Floatation Cost 1050.76 20.562 8 Years to Maturity Growth Rate 8.70% 5 Dividend expected 9 2.78 10 YTM (Cost of Debt) Cost of Equity 22.22% 8.70% 11 Tax rate 40% 12 Post tax Cost of Debt 5.22% 13 Weight of Debt 35% 14 Cost of Preferred Equity Weight of Preferred Equity 2% Cost of Preferred Stock = Annual dividend/Current price 15 Weight of Common Equity 63% 16 17 Annual Dividend 16.00% WACC 18 Current Price 92.25 19 Cost of Preferred Stock 8.67% 20

A C D E F Cost of Common Equity 2 Cost of Debt D1 We need to calculate YTM for this bond issue, which is cost of debt We need to use constant growth dividend discount model for this + g PO r = Price of Common Stock Par Value 1000 22.35 6 Coupon Rate 7 Market price 8 Years to Maturity Floatation Cost 0.1 0.08 1050.76 Price Net of Floatation Cost -E5*(1-E6) Growth Rate 5 0.087 Dividend expected 2.78 10 YTM (Cost of Debt) =RATE (B8,B6*B5,-B7,B5) Cost of Equity = (E9/E7)+E8 11 Tax rate 0.4 (1-B11) B10 12 Post tax Cost of Debt Weight of Debt 0.35 14 Cost of Preferred Equity Weight of Preferred Equity 0.02 Weight of Common Equity 0.63 Cost of Preferred Stock Annual dividend/Current price 17 Annual Dividend 18 Current Price (B12 E13)+(B19*E14)+(E10* E15) WACC 92.25 19 Cost of Preferred Stock B17/B18