The Saunders Investment Bank has the following financing outstanding.
Debt: |
120,000 bonds with a coupon rate of 8 percent and a current price quote of 110; the bonds have 20 years to maturity. 290,000 zero coupon bonds with a price quote of 17.5 and 30 years until maturity. Assume semiannual compounding.
|
SOLUTION:
calculation of market value weight |
|||
Financing |
working |
market value |
Weight |
8% bond |
120000*1100 |
132000000 |
35.05% |
zero coupon bond |
290000*175 |
50750000 |
13.47% |
preferred stock |
210000*70 |
14700000 |
3.90% |
Equity |
3200000*56 |
179200000 |
47.58% |
total market value |
376650000 |
100.00% |
Calculation of cost of capital:
8 percent bond: |
|
1100=40*(PVIFA r%,40) + 1000*(PVIF r%,40) |
|
r=3.53% |
|
since the coupon payments are semi-annual , YTM on bonds is |
|
3.53%*2 |
7.06% |
after tax cost of 8% coupon debt = 7.06*(1-0.4) |
4.24% |
zero coupon bond: |
|
175=1000*(PVIF r%,60) |
|
r=2.95% |
|
since the coupon payments are semi-annual , YTM on bonds is |
|
2.95%*2 |
5.90% |
after tax cost of zero coupon debt = 5.90*(1-0.4) |
3.54% |
cost of preferred stock (rp)=Dividend/market price=6/70 |
8.57% |
cost of equity (re) = risk free rate + beta*market risk premium |
|
0.04+1.05*0.07 |
11.35% |
calculation of WACC |
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Financing |
after tax cost of capital |
weight |
|
a |
b |
a*b |
|
8% bond |
4.24% |
35.05% |
1.48% |
zero coupon bond |
3.54% |
13.47% |
0.48% |
preferred stock |
8.57% |
3.90% |
0.33% |
Equity |
11.35% |
47.58% |
5.40% |
WACC |
7.70% |
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