Question

DQ Industries is analyzing their capital budgeting options and need to make sure their WACC is correct. The current T-Bill rate is 2.5%, market return 10%, and their beta is .9. Their capital structure consists of $6,000,000 in equity and $4,000,000 in 20 year bonds that sold 7 years ago for $1010 but $20 in flotation costs were paid. The coupon rate is 5.4% and payment is semi-annual. Tax rate is 40%.

What is their cost of debt?

What is their cost of equity?

What is their WACC?

Continuing with DQ Industries, now that they have their current WACC, if they go forwards with the proposed capital project they will need an additional $2,000,000, which will be obtained via a loan at a stated interest rate of 5.5%. What will be the new WACC?

Answer 1

COST OF DEBT

Bond Face Value

$1,000

Selling Price per bond

$1,010

Flotation Cost per bond

$20

Pv

Net amount received per bond

$990

Nper

Number of semi annual periods

40

(20*2)

Pmt

Semi annual coupon payment

$27.00

(1000*5.4%)/2

Fv

Amount to be paid on maturity

$1,000

RATE

Semi annual yield to maturity

2.7415%

(Using RATE function of excel with Nper=40, Pv=-990, Pmt=27, Fv=1000)

Before tax annual cost of debt

5.4829%

(2.7415*2)

After Tax Cost of Debt =5.4829*(1-Tax Rate)

Cd

After Tax Cost of Debt =

3.29%

(5.4829*(1-0.4)

COST OF EQUITY

Rs=Rf+Beta*(Rm-Rf)

Rs=Required Return on shares

Rf=Risk free rate =2.5%

Rm=Market return=10%

Beta=0.9

Required Return=2.5+0.9*(10-2.5)=

9.25%

Ce

Cost of Equity

9.25%

A

Amount of Equity

$6,000,000

B

Amount of Debt

$4,000,000

C

Total Capital

$10,000,000

We=A/C

Weight of Equity

0.60

Wd=B/C

Weight of Debt

0.40

WACC=Cd*Wd+Ce*We

WACC=3.29%*0.4+9.25%*0.6=

6.87%

Loan amount

$2,000,000

Cl

After tax cost of loan =5.5*(1-0.4)

3.30%

D

Amount of Equity

$6,000,000

E

Amount of Debt

$4,000,000

F

Loan amount

$2,000,000

G

Total Capital

$12,000,000

We=D/G

Weight of Equity

0.50

Wd=E/G

Weight of Debt

0.33

Wl=F/G

Weight of Loan

0.17

WACC=We*Ce+Wd*Cd+Wl*Cl

WACC=3.29%*0.33+9.25%*0.5+3.30%*0.17

6.27%

NEW WACC =6.27%

D11 =RATE(D8,09,-D7,010) А в D E F G H I Pv COST OF DEBT Bond Face Value Selling Price per bond Flotation Cost per bond Net amount received per bond Number of semi annual periods Semi annual coupon payment Amount to be paid on maturity Semi annual yield to maturity Before tay annual cost of debt Nper Pmt $1,000 $1,010 $20 $990 40 (202) $27.00 (1000*5.4%)/2 $1,000 2.7415%! (Using RATE function of excel with Nper=40, Pv=-990, Pmt=27, Fv=1000) 5.4820042 74152 RATE