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New Beginnings has the following capital structure; 6.5% First Mortgage Bonds - $70,000,000 outstanding: 8% senior sub-ordina
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Answer #1

Answer

  1. 8.38%
  1. 7.87%

  1. What is the New beginning WACC

Formula for calculating WACC = Kd * Wd + Ke * Wd + Kp * Wp

Kd = after tax cost of debt

Wd = Weight of Debt

Ke = Cost of Equity

We = Weight of Equity

Kp = Cost of Preference shares

Wp = Weight of Preference Shares

Calculation of total Capital and Weight of each component

Sl#

Types of capital

Cost Denoted by (1)

Interest Rate (2)

After tax rate of interest (Applicable for Debt only)(3)

Value (4)

Weight ((B÷4)*100)

Weight Denoted by

Debt

1

6.5% First Mortgage Bond

Kd1

6.5%

4.03%

$70,000,000

29.92%

Wd1

2

8% Senior Sub Ordinated Bond

Kd2

8%

4.96%

$36,000,000

15.38%

Wd2

Preference Shares

3

Class A

Kp1

4.5%

NA

$18,000,000

7.69%

Wp1

4

Class B

Kp2

6%

NA

$15,000,000

6.41%

Wp2

Equity Shares

5

Common Equity

Ke

14%

NA

$95,000,000

40.60%

We

Total (B)

$234,000,000

                                                                                                                          

WACC = Kd1 * Wd1 +Kd2 * Wd2 +Kp1*Wp1 + Kp2 * Wp2 +Ke *We

            =4.03%*29.92% +4.96%*15.38%+ 4.5%*7.69% + 6%*6.41%+14% * 40.60%

            =8.3832%

            =8.38%

Calculation of after tax Cost of Debt

Formula for calculating after tax cost of Debt = Interest rate * (1 – Tax Rate)

  1. For 6.5% First Mortgage Bond = 6.5% * (1 – 38%)

= 4.03%

  1. For 8% Senior Sub Ordinated Bond = 8% * (1 -38%)

= 4.96%

Calculation of Weight

Weight of each component = (Value of the component ÷ Total Capital) * 100

Example

Weight of 6.5% First Mortgage Bond = ($70,000,000 ÷ $234,000,000) * 100

                                                =29.92%

Weight of 8% Senior Sub Ordinated Bond = ($36,000,000 ÷ $234,000,000) * 100

                                                            =15.38%

  1. WACC after new issue

Sl#

Types of capital

Cost Denoted by (1)

Interest Rate (2)

After tax rate of interest (Applicable for Debt only)(3)

Value (4)

Weight ((B÷4)*100)

Weight Denoted by

Debt

1

6.5% First Mortgage Bond

Kd1

6.5%

4.03%

$70,000,000

26.52%

Wd1

2

8% Senior Sub Ordinated Bond

Kd2

8%

4.96%

$36,000,000

13.64%

Wd2

3

Project Financing Bond

Kd3

6.3%

3.906%

$30,000,000

11.36%

Wd3

Preference Shares

4

Class A

Kp1

4.5%

NA

$18,000,000

6.82%

Wp1

5

Class B

Kp2

6%

NA

$15,000,000

5.68%

Wp2

Equity Shares

6

Common Equity

Ke

14%

NA

$95,000,000

35.98%

We

Total (B)

$264,000,000

100%

WACC = Kd1 * Wd1 +Kd2 * Wd2 + Kd3*Wd3 +Kp1*Wp1 + Kp2 * Wp2 +Ke *We

            =4.03%*26.52%+4.96%*13.64%+3.906%*11.36%+4.5%*6.82%+6%*5.68%+14%*35.98%

            =7.873%

            =7.87%

Calculation of after tax Cost of Debt

Formula for calculating after tax cost of Debt = Interest rate * (1 – Tax Rate)

  1. For Project Financing Bond = 6.3% * (1 – 38%)

=3.906%

Calculation of Weight

Weight of each component = (Value of the component ÷ Total Capital) * 100

Example

Weight of Project Financing Bond = ($30,000,000 ÷ $264,000,000) * 100

                                                =11.36%

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