Question

Kuhn company is considering a new project that will require an initial investment of $4 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 15 years with a face value of $1,000, an annual coupon rate of 11%, and a market price of $1,555.38. 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 $92.25 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 $2.78 at the end of 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 9.2%, and they face a tax rate of 40%. What is Kuhn's WACC for this project? Please show work.
a. 7.65%

b. 9.00%

c. 10.35%

d. 9.45%

Answer 1

Answer:

b. 9.00%

Explanation:

For the computation of WACC first we need to follow some steps which is shown below:-

Step 1

Cost of debt = 5.48% which is explained with the help of attachment.

Given that,  

Present value = $1,555.38

Future value or Face value = $1,000  

PMT = 1,000 × 11% = $110

NPER = 15 years

The formula is shown below:  

= Rate(NPER;PMT;-PV;FV;type)  

The present value come in negative  

So, after applying the above formula, the cost of debt is

Step 2

Cost of preferred stock = Annual preferred dividend ÷ Price

= $8 × $92.25

= 0.086721

Step 3

Cost of equity = Dividend ÷ (Stock price × (1 - flotation cost)) + Growth rate

= 2.78 ÷ (33.35 × (1 - 0.08)) + 0.092

= 18.26%

WACC = Weight of debt × Cost debt) + (Weight of preference stock × Cost of preference stock) + (Weight of equity × cost of equity)

= (0.58 × (0.0548 × (1 - 0.4)) + (0.06 × 0.086721) + (0.36 × 0.1826068)

= 9.00%