Question

Question 17 Use the following data for the next 4 questions: (Take a note of the information of your cale the last question) Debt 20 bonds with 8 % coupon rate, payable annually, $1,000 par value, 15 years to maturity, selling at $970 per bond. Common Stock 500 shares of common stock outstanding. The stock sells for a price of $112 per share and has a beta of 1.6 Preferred Stock 110 preferred shares outstanding, currently trading at $120 per share; with an annual dividend payment of $7 Market The market risk premium is 9% and the risk free rate is 2% Tax Rate 21% What is the cost of debt? (You don't need to calculate anything here. Use the logic of the 2nd key relationsh (You may not need all the information from above to answer this question) 6.55 % 8.36%

Answer 1

Weighted average cost of capital is cost of capital of a firm with different financing methods  

So, we need to calculate cost of each component and multiply with its weight to get WACC.

So, let us calculate cost of each component  

A) cost of debt is yield to maturity on the bonds  

    Yield is 8.36% (calculation in workbook inserted below) (answer to question 1)

    We get tax shield on interest payments so we need to reduce tax% from the cost  

    Tax rate is 21%  

    So, after tax cost of debt is 8.36(1-0.21) =6.6044%

B) cost of preference shares can be calculated by below formula  

     = dividend/price per share

     = 7/120 = 5.8333% (question 2)

C) cost of equity  

    According to CAPM approach cost of equity will be equal to risk free rate plus beta times market risk        premium  

    Risk premium is = market return – risk free rate  

    = 2% + 1.6(9%) = 16.4% (question 3)

wacc is 12.68%(question 4)

security	market value	weight	cost	product
debt	19400	0.22	6.60	1.445146727
preffred stock	13200	0.15	5.83	0.8685778781
equity	56000	0.63	16.40	10.36568849
total	88600	1	wacc	12.6794