Question

1. Micro Advantage issued a $5,500,000 par value, 16-year bond a year ago at 95 (i.e., 95% of par value) with a stated rate of 8%. Today, the bond is selling at 105 (i.e., 105% of par value). If the firm’s tax bracket is 30%, what is the current after-tax cost of this debt?

2. Micro Advantage has $5,500,000 preferred stock outstanding that it sold for $22 per share. The preferred stock has a per share par value of $25 and pays a $5 dividend per year. The current market price is $27 per share. The firm’s tax bracket is 31%. What is the after-tax cost of the preferred stock?

3. In addition to the bonds and preferred stock described in requirements 1 and 2, Micro Advantage has 63,000 shares of common stock outstanding that has a par value of $10 per share and a current market price of $180 per share. The expected after-tax market return on the firm’s common equity is 21%. What is Micro Advantage’s weighted-average cost of capital (WACC)?

Answer 1

Calculation of Weighted Average Cost of Capital (WACC) Book value basis
ELEMENT	AMOUNT($)	WEIGHT	SPECIFIC COST OF CAPITAL	OVERALL COST OF CAPITAL
BOND	55,00,000	0.0595	0.0515	0.003
PREFFERD STOCK	55,00,000	0.4729	0.2977	0.1407
COMMON STOCK	6,30,000	0.0541	0.21	0.0113
		1		0.155
			WACC = 15.5%

COMPUTATION OF SPECIFIC COST OF CAPITAL AS FOLLOWS

K_d = {I(1-t)+RV-NS/n}/{RV+NS/2}

={8*0.70+100-95/15}/{100+95/2}

=0.0595

K_p={D(1-dt)/NS}

=5(1+0.31)/$22}

=0.2977

K_e= 0.21