Question

Consider the case of Kuhn Co.

Kuhn Co. is considering a new project that will require an initial investment of $45 million. It has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. Kuhn has noncallable bonds outstanding that mature in five years with a face value of $1,000, an annual coupon rate of 10%, and a market price of $1,050.76. The yield on the company's current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividend of $8 at a price of $95.70 per share. You can assume that Jordan does not incur any flotation costs when issuing debt and preferred stock.

Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay a dividend of $1.36 at the end of the next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 8.7%, and they face a tax rate of 40%. Determine what Kuhn Company's WACC will be for this project.

a. 8.67%

b. 7.02%

c. 7.85%

d. 8.26%

Answer 1

Answer is d

с D D1 r = Po+g Cost of Common Equity We need to use constant growth dividend discount model for this Price of Common Stock 33.35 Floatation Cost 8% Price Net of Floatation Cost 30.682 Growth Rate 8.70% Dividend expected 1.36 Cost of Equity 13.13% в 1 2 Cost of Debt 3 We need to calculate YTM for this bond 4 issue, which is cost of debt 5 Par Value 1000 6 Coupon Rate 10% 7 Market price 1050.76 8 Years to Maturity 9 10 YTM (Cost of Debt) 8.70% 11 Tax rate 40% 12 Post tax Cost of Debt 5.22% 13 14 Cost of Preferred Equity 15 Cost of Preferred Stock = Annual 16 dividend/Current price 17 Annual Dividend 18 Current Price 95.7 19 Cost of Preferred Stock 8.36% 20 21 Weight of Debt Weight of Preferred Equity Weight of Common Equity 58% 6% 36% WACC 8.26%

Cost of Common Equity D1 We need to use constant growth dividend discount model for this r= a + g 2 Cost of Debt 3 We need to calculate YTM for this bond issue, which is cost of debt 4 5 Par Value 1000 6 Coupon Rate 0.1 7 Market price 1050.76 8 Years to Maturity Price of Common Stock Floatation Cost Price Net of Floatation Cost Growth Rate Dividend expected Cost of Equity 33.35 0.08 =E5*(1-E6) 0.087 1.36 =(E9/E7)+E8 0.58 10 YTM (Cost of Debt) =RATE(B8,B6*B5,-B7,85) 11 Tax rate 0.4 12 Post tax Cost of Debt = (1-B11)*810 13 14 Cost of Preferred Equity 15 Cost of Preferred Stock = Annual dividend/Current price 16 17 Annual Dividend 18 Current Price 19 Cost of Preferred Stock =B17/B18 Weight of Debt Weight of Preferred Equity Weight of Common Equity 0.06 0.36 WACC =(B12*E13)+(B19*E14)+(E10*E15) 95.7 20