Question

Estimating Weighted-Average-Cost-of-Capital You are about to start to consider a batch of new capital budgeting projects. Before you begin you need to estimate your company's Weighted-Average-Cost-of-Capital (WACC). The firm operates in the 35% marginal tax bracket. There are four sets of sheet. Calculate the WACC including all four classes of liabilities. A. There are 5,760,000 shares of common stock outstanding. These are trading at $52.36 per share. You have decided to use the Gordon Growth Model to estimate the retun required by your firm's shareholders. In the most recent annual report the earnings per share (EPS) were $3.85. You feel that it is reasonable to assume that earnings will grow at about 1.30% into the foreseeable future. B. There is an issue of 1.582,000 shares of preferred stock. These securities promise an (perpetual) annual dividend of $3.40. The shares are currently trading for $49.27 There is an issue of 145.000 coupon bonds, which have a face value of $1.000. pay C. 4.25% (annual) coupons, and mature in 12 years. The securities are currently trading for $935.30 D. The firm also has 110 short-term commercial paper notes outstanding that have a face value of $500.000, and mature in 14 days. These are cumently selling for $499.573.46.

Answer 1

Equity

Market Capitalization = 5,760,000 × $52.36

= $301,593,600

Market capitalization is $301,593,600.

Cost of equity = [$3.85 × (1+ 1.30%) / $52.36] + 1.30%

= ($3.90/ $52.36) +1.30%

= 7.45% + 1.30%

= 8.75%

Cost of equity is 8.75%.

Preferred stock

Market value of preferred stock = 1,582,000 × $49.27

= $77,945,140

Market value of preferred stock is $77,945,140.

Cost of preferred stock = $3.40 / $49.27

= 6.90%

Cost of preferred stock is 6.90%.

Bond

Market value of bond = 145,000 × $935.30

= $135,618,500

Market value of bond is $135,618,500.

YTM of bond that is before tax cost of bond is calculated in excel and screen shot provided below:

B7 RATE (B4,B3,-B5,B1) 1 Par Value 2 Coupon rate 3 Annual Coupon payment 4 Year Remaining for maturity 5 Current Price 6 $1,000 4.250% $42.50 12 $935.30 year 7 Yield to maturity 4.98%

Before tax cost of debt is 4.98%

Tax rate = 35%

After tax cost of long term debt = 4.98% × (1 - 35%)

= 3.24%

After tax cost of long term debt is 3.24%

Market value of short term debt = 110 × $500,000

= $55,000,000

Market value of short term debt is $55,000,000.

Cost of short term debt = [($500,000 / $499,573.46) ^ (360 / 14)] - 1

= 1.0222 - 1

= 2.22%

Cost of short trem debt is 2.22%.

Market value of total capital = $301,593,600 + $77,945,140 + $135,618,500 + $55,000,000

= $570,157,240.

Market value of total capital is $570,157,240.

Weight of equity = 52.90%

Weight of preferred stock = 13.67%

Weight of long term debt = 23.79%

Weight of short term debt = 9.65%.

Now, WACC is calculated below:

WACC = (52.90% × 8.75%) + (13.67% × 6.90%) + (23.79% × 3.24%) + (9.65% × 2.22%)

= 4.63% + 0.94% + 0.77% + 0.21%

= 6.56%

WACC of company is 6.56%.