Question

6 You are looking at the following information: 5,500 5.5 percent coupon bonds outstanding, $1,000 par Debt: value, 17 years to maturity, selling for 104 percent of par, the bonds make semiannual payments 110,000 shares outstanding, selling for $65 per share; the 1 polnts Common stock beta is 1.18. Preferred stock 17,500 shares of 5 percent preferred stock (review my Ch.8 slide 43: what does "..% preferred stock"phrase mean?) outstanding, currently selling for $105 per share. 6.5 percent market risk premium and 5 percent risk-free rate Market: The company is in the 33 percent tax rate bracket based on its corporate income. Required: Find the WACC. (Do not round your intermediate calculations.)

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=65*110000

=7150000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*5500*1.04

=5720000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=105*17500

=1837500

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=7150000+5720000+1837500

=14707500

Weight of equity = MV of Equity/MV of firm

Weight of equity = 7150000/14707500

W(E)=0.4861

Weight of debt = MV of Bond/MV of firm

Weight of debt = 5720000/14707500

W(D)=0.3889

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 1837500/14707500

W(PE)=0.1249

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 5 + 1.18 * (6.5)

Cost of equity% = 12.67

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =17x2

1040 =∑ [(5.5*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^17x2

k=1

YTM = 5.1441839068

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

After tax cost of debt = 5.1441839068*(1-0.33)

= 3.446603217556

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 5/(105)*100

=4.76

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

WACC=3.45*0.3889+12.67*0.4861+4.76*0.1249

WACC =8.09%