Question

(b) Calculate the WACC for the following firm: Debt: 40,000 bonds with coupon rate of 5% paid annually and face value of $100. The bonds are currently trading for $85 each and have 10 years until maturity. The yield to maturity of the bonds is 7.15% p.a. before tax. Common stock: 150,000 ordinary shares currently trading for $50 per share. The most recent dividend from the stock has been $5 per share and the dividend is expected to grow at a constant rate of 10%. Preferred stock: 100,000 preference shares currently trading for $17 per share. The yearly dividend is $2.5 per share. Market: The corporate tax rate is 25%. (6 marks)

Answer 1

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

MV of equity=50*150000

=7500000

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

MV of Bond=100*40000*0.85

=3400000

MV of firm = MV of Equity + MV of Bond

=7500000+3400000

=10900000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 7500000/10900000

W(E)=0.6881

Weight of debt = MV of Bond/MV of firm

Weight of debt = 3400000/10900000

W(D)=0.3119

Cost of equity

As per DDM

Price = recent dividend* (1 + growth rate )/(cost of equity - growth rate)

50 = 5 * (1+0.1) / (Cost of equity - 0.1)

Cost of equity% = 21

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

After tax cost of debt = 7.15*(1-0.25)

= 5.3625

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

WACC=5.36*0.3119+21*0.6881

WACC =16.12%