Question

Dr. Campos is deciding on which equipment to acquire. Each is worth 20 million pesos. He is thinking if financing the 50% equity, 25 % via 5 year term loan at 7.5 % annual effective interest and the balance via 100peso/ share callable preferred shares of stock that promises to pay 4% quarterly dividends. His company consistently paid the 5% semi annual dividends on its common shares. Calculate the weighted average cost of capital of the project. Disregard taxes in your computations. Assume full principal payment on year 5.

Answer 1

Proportion of common equity = W_e = 50%

cost of equity, K_e = Annual dividend yield = 2 x semi annual dividend yield =2 x 5% = 10%

Proportion of preferred equity, W_p = 25%

Cost of preferred stock = Annual dividend / Price = 4 x 4% x 100 / 100 = 16%

Proportion of debt, W_d = 725%

Post tax cost of debt, K_d = pre tax cost of debt as taxes are to be disregarded = 7.5%

Hence, WACC = W_e x K_e + W_p x K_p + W_d x K_d = 50% x10% + 25% x 16% + 25% x 7.5% = 10.875%