Question

The Saunders Investment Bank has the following financing outstanding. Debt: 50,000 bonds with a coupon rate of 7 percent and a current price quote of 110; the bonds have 20 years to maturity. 220,000 zero coupon bonds with a price quote of 18 and 30 years until maturity. Assume semiannual compounding. Preferred stock: 140,000 shares of 5 percent preferred stock with a current price of $80, and a par value of $100. Common stock: 2,500,000 shares of common stock; the current price is $66, and the beta of the stock is 1.2. Market: The corporate tax rate is 35 percent, the market risk premium is 6 percent, and the risk-free rate is 3 percent. What is the WACC for the company

Answer 1

Answer:

the company's WACC = 7.85%

Explanation:

we must first determine the market value of debt, preferred stocks and common stocks:

debt 1 = 50,000 x $1,000 x 1.1 = $55,000,000, weight 20.31%

debt 2 = 220,000 x $1,000 x 0.18 = $39,600,000, weight 14.62%

preferred stock = 140,000 x $80 = $11,200,000. weight 4.14%

common stock = 2,500,000 x $66 = $165,000,000, weight 60.93%

total market value = $270,800,000

cost of debt 1:

YTM = {35 + [(1,000 - 1,100)/40]} / [(1,000 + 1,100)/2] = 32.5/1,050 = 3.095 x 2 = 6.19%

after tax cost = 6.19% x 0.65 = 4.02%

cost of debt 2:

price = face value / (1 + i)ⁿ

180 = 1,000 / (1 + i)³⁰

(1 + i)³⁰ = 1,000 / 180 = 5.55555

³⁰√(1 + i)³⁰   = ³⁰√5.55555

1 + i = 1.058825

i = 0.058825 = 5.8825%

after tax cost = 5.8825% x 0.65 = 3.82%

cost of preferred stocks = 5 / 80 = 6.25%

cost of equity:

Re = Rf + (B x MP) = 3% + (1.2 x 6%) = 10.2%

the company's WACC = (60.93% x 0.102) + (4.14% x 0.0625) + (20.31% x 0.0402) + (14.62% x 0.0382) = 6.21% + 0.26% + 0.82% + 0.56% = 7.85%