Question

Nevada Hydro is 40% debt financed and had a WACC of 9.7%: WACC = (1 - T. ), p. +re = (1 - .35)(.085) (.40) +.125(.60) = .097 Goldensacks Company is advising Nevada Hydro to issue $75 million of preferred stock at a dividend yield of 9%. The proceeds would be used to repurchase and retire common stock. The preferred issue would account for 10% of the pre-issue market value of the firm. Goldensacks argues that these transactions would reduce Nevada Hydro's WACC to 9.4%: WACC=(1-.35)(.0857.40)+.090.10)+.125(.50) = .094 or 9.4% Do you agree with the calculations? Explain. Give new calculation if you disagree.

Answer 1

The calculation is wrong.

In the given case it is mentioned that the company will issue preferred stock and the proceed would be used to repurchase and retire common stock. Futher it also mentioned that preferred issue would account for 10% of the pre issue market value of the firm. Market value is derived by multiplying outstanding share with price of shares.

Currently equity share is 60%.

So Preferred stock to be issued = 10%*60% i.e. 6%

Common stock after issue =60%-6% i.e.54%

WACC =(1-.35)(.085)(.40)+.09(.06)+0.125*(0.54) i.e.0.095 or 9.5%