Question

of preferred stock outstanding carrying a $9.00 per share annual dividend, and 220,000 10% coupon bonds outstanding, par value $1,000 each, interest paid semiannually. The common stock currently sells for $42 per share and has a beta of 1.15, the preferred stock currently sells for $80 per share, and the bonds have 17 years to maturity and sell for 91 percent of par. The market risk premium is 11.5 percent, T-bills are yielding 7.5 percent, and the firm's tax rate is 32 percent. What is Titan's after-tax cost of debr? 2. What is Titan's cost of preferred stock? 3. What is Titan's cost of equity? 4. What weights should be given to Debt, Preferred Stock, and Common Stock in Titan's cost of capital calculation What is Titan's WACC? 5.

Answer 1

Answer to Requirement 1.

Debt:

Number of bonds outstanding = 220,000
Face Value = $1,000
Current Price = 91%*$1,000 = $910

Value of Debt = 220,000 * $910
Value of Debt = $200,200,000

Annual Coupon Rate = 10%
Semiannual Coupon Rate = 5%
Semiannual Coupon = 5%*$1,000 = $50

Time to Maturity = 17 years
Semiannual Period to Maturity = 34

Let semiannual YTM be i%

$910 = $50 * PVIFA(i%, 34) + $1,000 * PVIF(i%, 34)

Using financial calculator:
N = 34
PV = -910
PMT = 50
FV = 1000

I = 5.60%

Semiannual YTM = 5.60%
Annual YTM = 2 * 5.60%
Annual YTM = 11.20%

Before-tax Cost of Debt = 11.20%
After-tax Cost of Debt = 11.20% * (1 - 0.32)
After-tax Cost of Debt = 7.616%

Answer to Requirement 2.

Preferred Stock:

Number of shares outstanding = 900,000
Current Price = $80
Annual Dividend = $9.00

Value of Preferred Stock = 900,000 * $80
Value of Preferred Stock = $72,000,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $9.00 / $80
Cost of Preferred Stock = 11.25%

Answer to Requirement 3.

Equity:

Number of shares outstanding = 14,000,000
Current Price = $42

Value of Common Stock = 14,000,000 * $42
Value of Common Stock = $588,000,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 7.50% + (1.15 * 11.50%)
Cost of Common Equity = 20.725%

Answer to Requirement 4.

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $200,200,000 + $72,000,000 + $588,000,000
Value of Firm = $860,200,000

Weight of Debt = $200,200,000 / $860,200,000
Weight of Debt = 0.2327

Weight of Preferred Stock = $72,000,000 / $860,200,000
Weight of Preferred Stock = 0.0837

Weight of Common Stock = $588,000,000 / $860,200,000
Weight of Common Stock = 0.6836

Answer to Requirement 5.

WACC = Weight of Debt*After-tax Cost of Debt + Weight of Preferred Stock*Cost of Preferred Stock + Weight of Common Stock*Cost of Common Stock
WACC = (0.2327 * 0.07616) + (0.0837 * 0.1125) + (0.6836 * 0.20725)
WACC = 0.1688 or 16.88%