Question

12- Domum Corporation capital structure is 45% debt, 40 % common stock from retained earnings and 15% newly issued common stocks with floating cost of 5 %. The company has already paid $2.2 dividend and its tax rate is 25% and it's stock beta is 1.2. The company constant growth rate is 4 % and free market rate and risk premium are 3.5% and 10 % respectively. Domum pays 7% coupon to its bond holders and its bond face value is $1000 which current price is $875 in the market and bonds mature in 25 years. The stock is currently selling for $14.77. what is Domum's WACC?

please list steps if possible

Answer 1

first we need to find the cost of each category of funds

step 1.

cst of old Equity	= Dividend for next year/ equity share price(1- floating cost ) + growth
growth	4%
Dividend of this year	2.2
dividend of next yr	2.2*(1+0.04)
	$                     2.29
floating cost	5%
	=2.29/14.77(1-0.05) +0.04
	=0.1632+0.04
	=0.2032
	=20.32%

step 2.

Cost of new equity= R(f)+ β{E(m)-R(f)}

·                      R(f) = Risk-Free Rate of Return= 3.5%

·                      [E(m)-R(f)] = equity risk premium= 10%

Cost of equity = 3.5% + 1.2*10%

0.155

0.155

Or 15.50%

step 3.

Cost of Bond

YTM= (C+ (F-P)/n)/(F+P/2)

C= coupon amount= 1000*0.07= 70

F= face value=1000

P= Price= 875

N= tenor= 25

YTM= (70+(1000-875)/25)/(1000+875/2)

YTM= (70+5)/937.5

YTM= 0.08 or 8%

step 4. after calculating the cost , we will then calculate the WACC

Particulars	1. Cost	2. tax	3. After tax cost	weights ( given)	5. after tax cost * weights
Bonds	8.00%	25%	=0.08*(1-0.25 )= 0.06 or 6%	0.45	0.06*.45	0.027
stock from retained earnings	20.32%	0%	20.32%	0.40	0.2032*0.40	0.08
Equity	15.50%	0%	15.50%	0.15	0.1550*0.15	0.02
			total			0.1315

basically , WACC= {coat of debt (1-t)*debt/ debt+ equity}+ {cost of equity *equity/debt+ equity}

so WACC here = 13.15%