Question

2. A company wants to fund a proiect. The amount needed is 80,000,000. There will be four sources A Bank Loan of 20 million. Rond Issuance of 30 million, Common Stock of 10 million and the rest in Retained Earnings. Taxes are at a 40% rate (including Federal State and Local). The Bank Loan is 12% annual paid monthly The bond issuance is 8% paid quarterly, the dividends per share common stock is 15 and the price per share is 200. Compute the weighted average cost of capital.

Answer 1

Calculation of Cost of Capital:

1. Bank Loan: 12% per annum paid monthly. Effective Interest rate per annum will be:

Effective Interest rate (r) = (1 + i/n)^n - 1

= (1+0.12/12)^12-1

= (1.01)^12-1

=0.126825 i.e. 12.6825%

Cost of Bank Loan (after Tax)= 12.6825- Tax rate i.e. 40% of 12.6825 = 7.6095%

Cost of Bond :

8% Interest paid Quarterly, so effective Interest rate annum will be:

Effective Interest rate (r) = (1 + i/n)^n - 1

= 1+(0.08/4)^4-1

Effective Interest Rate of Bond= 8.2432%

Cost of Bond after Tax= 8.2432%- Tax rate i.e. 40% of 8.2432 = 4.9459%

Cost of Equity & retained Earning (Ke):

Ke = Dividend Per Share/ Price Per Share

Ke= 15/200 = 0.075 i.e 7.5%

Calculation of Weighted Average Cost:

Capital Source	$ in Million	Portion	Cost in %	= Portion x Cost
Bank Loan	20	0.25	7.6095	1.9024
Bond	30	0.375	4.9459	1.8547
Common Stock	10	0.125	7.5	0.9375
Retained earning	20	0.25	7.5	1.8750
			WACC	6.5696

Therefore, as desired in question, WACC is 6.5696%.