Question

The Saunders Investment Bank has the following financing outstanding. Debt: 120,000 bonds with a coupon rate of 8 percent and a current price quote of 110.0; the bonds have 20 years to maturity. 290,000 zero coupon bonds with a price quote of 17.5 and 30 years until maturity. Preferred stock: 210,000 shares of 6 percent preferred stock with a current price of $70, and a par value of $100. Common stock: 3,200,000 shares of common stock; the current price is $56, and the beta of the stock is 1.05. Market: The corporate tax rate is 40 percent, the market risk premium is 7 percent, and the risk-free rate is 4 percent. What is the WACC for the company?

Answer 1

Answer:

R_Wacc =  11,35% (48%) + 8,57% (4%) + 4,18% (35%) + 3,59% (13%) =      7,70%

Explanation:

Re:   11,35%  Cost of Common Equity  

Re:   8,57%  Cost of Preferred STOCK  

Re:   4,18%  Cost of Debt BONDS  

Rd:   3,59%  Cost of Zero BONDS  

• Equity :  

$179,200,000   Market Value of the firm's Common Equity  

• Preferred Stock:  

$14,700,000   Market Value of the firm's Preferred STOCK  

• Debt bonds :  

$132,000,000   Market Value of the firm's Debt BONDS  

• Zero bonds :  

$49,300,000   Market Value of the firm's ZERO BONDS  

V:   $375,200,000   E+D = Total Market Value of the firm's financing  

E/V:   48%  Percentage of financing that is Common Equity  

PS/V:   4%  Percentage of financing that is Preferred Stock  

DB/V:   35%  Percentage of financing that is Debt Bonds  

ZB/V:   13%  Percentage of financing that is Zero Bonds  

Tc:    40% Corporate tax rate  

• Total Market Value      

Market value of debt  Bonds:  

120,000 x $1,000 x 110% = $132,000,000

Market value of debt Zero Coupon:  

290,000 x $1,000 x 17% =  $49,300,000

Market value of preferred stock:  

210,000 x $70 = $14,700,000

Market value of common stock:  

3,200,000 x $56 =  $179,200,000

TOTAL = $375,200,000

• Using the CAPM model we can calculate the costo of equity:      

R =   0,04 + 1,05(0,07) =  11,35%  

• The cost of debt is the YTM of the bonds, so:      

P0= $1,110 = $40(PVIFAR%,40) + $1,000(PVIFR%,40) =      

R =   6,97%    

• The aftertax cost of debt is:      

R_Bonds :  (1 - 0,4) x (0,0697) =  4,18%  

• The aftertax cost of zero coupon bonds is:        

Yield To Maturity = (Face Value/Current Bond Price)^(1/Years To Maturity)−1 =   5,98%

(Face Value/Current Bond Price) = '$1,000/$175           (1/Years To Maturity) = 1/30          

• The aftertax cost of debt is:          

R_ZeroB : (1 - 0,4) x (0,0598) = 3,59%      

• We can use the preferred stock pricing equation, which is the level perpetuity equation, so the required return on the company’s preferred stock is:      

Rp= D1/P0 =  $6/$70 = 8,57%  

Rp = Required Return   D1 = Dividend   P0 = Price