Question

Wohlers Co. considers a project that will require an initial investment of 5 million. It has a target capital structure of 30% debt, 5% preferred stock, and 65% common equity. Wholers Co. has outstanding 20-year noncallable bonds with a face value of $1,000. These bonds have a current market price of $1,181.96 and an annual coupon rate of 13%. The company faces a tax rate of 40%, and can sell shares of preferred stock that pay an annual dividend of $7.50 at a price of $89.25 per share. The company's common stock is currently selling for $22.35 per share and pays a dividend of $2.45 today. The common stock's growth rate is a constant rate of 9.2%. What will be the WACC for the project

Answer 1

Answer:

WACC = 16.18%

Explanation:

cost of equity (Re):

P₀ = Div₁ / (Re - g)

$22.35 = ($2.45 x 1.092) / (Re - 9.2%)

$22.35 = $2.6754 / (Re - 9.2%)

Re - 9.2% = $2.6754 / $22.35 = 11.97%

Re = 11.97% + 9.2% = 21.17%

after tax cost of debt:

YTM = {130 + [(1,000 - $1,181.96)/ 20]} / [(1,000 + $1,181.96)/ 2] = 120.902 / 1,090.98 = 11.08%

after tax cost of debt = 11.08% x (1 - tax rate) = 11.08% x 0.6 = 6.65%

cost of preferred stocks = $7.50 / $89.25 = 8.40%

WACC = (0.65 x 21.17%) + (0.05 x 8.4%) + (0.3 x 6.65%) = 13.76% + 0.42% + 2% = 16.18%