Question

4. [Ch 10] Sound & Vision Studios (SVS) has 6 million common shares outstanding which sell for $25 per share. SVS management is expected to set the next annual dividend at $2.50 per share, and investors and analysts expect all future dividends to grow by 7% per year, indefinitely. The current risk-free rate is 5.50%, the expected return on the market is 10%, and the stock has a beta of 2.2. SVS also has 1 million shares of 6% preferred stock outstanding (par value of $100) selling for $44 per share and 150,000 15-year, 8% annual coupon bonds outstanding, currently selling for 112% of par. If SVS is in the 35% tax bracket, then what is the firm's WACC?

Answer 1

As per CAPM Ке Rf+beta*(Rm-Rf) 0.055+2.2*10.10-0.055) 0.154 15.40% expected return As per Dividend discount Model Ке (D1/PO)+g (2.5/25)+0.07 0.17 17.00% Cost of Equity is taken as Average of above two 100 Cost of Equity Preference Face value preference dividend Market price Cost of preference shares (0.1540+0.17)/2 0.162 16.20% Coupon nper pmt PV 80 (6/44) Best Estimate 0.136363636 13.64% 16.20% 16.20% -1120 1000 RATE(15,80,-1120,1000) 6.707% 6.707% Rate YTM weight Debt preference Equity 150000 1120 1000000-44 600000025 Market value $ 168,000,000.00 $ 44,000,000.00 $ 150,000,000.00 362,000,000.00 After tax debt 0.06707*(1-0.35) 0.043593952) cost product 0.464 0.043593952 0.122 0.136363636 0.414 0.162 WACC WACC 0.0202 0.0166 0.0671 0.1039 10.39%