Question

12. A company sells bonds with a face value of $ 1,000 to make money to invest. He currently has $ 500,000 of dividends withheld from common stock and the sale of preferred stock for a total amount of $ 150,000 is approved. It is expected to receive $ 700,000 of debt with the sale of the bonds. These bonds are 20 years with a coupon interest rate of 10% per year. Sold at par. Also, it is known that common shares are currently trading at $ 15 and the expected dividend for next year is $ 3, with an expected growth of 2%. The preferred shares are sold at par, with a par value of $ 45 and pay an annual dividend of $ 10. Putting both the bonds and the preferred shares into circulation causes you a float cost of 2% of the nominal value of each instrument to the company. What is the minimum acceptable return for the company, if set as WACC + 2%? The tax rate paid by the company is 38%.

Answer 1

Component cost
after tax cost of debt	(coupon payment/net proceeds)*(1-tax rate)	(100/980)*(1-.38)	6.33%
coupon payment	1000*10%		70
net proceeds	1000*(1-.02)		980
cost of preferred stock	preferred dividend/net proceeds	10/44.1	22.68%
preferred dividend			10
net proceeds	45*(1-.02)		44.1
cost of common stock	(expected dividend/market price)+growth rate	(3/15)+2%	22.00%
WACC
source	value	weight	component cost	weight*component cost
debt	700000	0.518519	6.33%	0.032804
preferred stock	150000	0.111111	22.68%	0.025195
common stock	500000	0.37037	22.00%	0.081481
total	1350000
WACC = sum of weight*component cost				13.95%
minimum acceptable return for the company	WACC+2%	13.95%+2%		15.95%