Debt: 8,000 6.5 percent coupon bonds outstanding. $1,000 par value, 25 years to

Question

Debt: 8,000 6.5 percent coupon bonds outstanding. $1,000 par value, 25 years to maturity, selling for 106 percent of par, the bonds make semiannual payments Common stock: 310,000 shares outstanding, selling for $57 per share: the beta is 1.05. Preferred Stock: 15,000 shares of 4 percent preferred stock outstanding, currently selling for 72 per share Market: 7 percent market risk premium and 4.5 percent risk-free rate. WACC = Kd x Pd + Kpfd x Kpfd + Ke x Pe The proportions, costs and weighted costs are in decimals to 4 places Market Value Market Proportions Source Costs Weighted Costs Debt 0122 Preferred 1,080,000 Equity 6489 Total WACC

Explanation / Answer

Market Value of Debt = 106% of Par * No. of Bonds
Market Value of Debt = 106% of 1000 * 8000
Market Value of Debt = 8,480,000

Market Value of Preferred = Market value per share * Number of shares
Market Value of Preferred = 15000 *72
Market Value of Preferred = 1,080,000

Market Value of Equity = Market value per share * Number of shares
Market Value of Equity = 310000 * 57
Market Value of Equity = 17,670,000

Total Market Value = 8480000 + 1080000 + 17670000
Total Market Value = 27,230,000

Market Proportion of Debt = 8,480,000/ 27,230,000 = 0.3114
Market Proportion of Preferred = 1,080,000 / 27,230,000 = 0.0397
Market Proportion of Equity = 17,670,000/27,230,000 = 0.6489

Cost of Debt
Current Price = PV of semi Annual Coupon + PV of Facevalue after 50 semi years
Current Price = PV of (6.5%/2*1000) for 50 years + PV of 1000 after 50 semi years
1060 = PV of 32.50 for 50 years + PV of 1000 after 50 semi years
1060 = 32.50/(1+r)1 + 32.50/(1+r)2 + 32.50/(1+r)3 + ........... 32.50/(1+r)50 + 1000/(1+r)50
Solve for r - using Financial calculator or excel using IRR function
r = 0.0302
Annual = 0.0302 * 2 = 0.0604
After Tax = 0.0604 * ( 1- 35%) = 0.0392

Cost of Preferred
Cost of Preferred = Dividend / MV
Cost of Preferred = 4/72
Cost of Preferred = 0.0556

Cost of Equity
Cost of Equity = RFR + Beta * Market risk Premium
Cost of Equity = 4.5% + 1.05 * 7%
Cost of Equity = 0.1185

Weighted Cost of Debt = Cost of Debt * Market Proportion of Debt = 0.0392*0.3114 = 0.0122
Weighted Cost of Preferred = Cost of Preferred * Market Proportion of Preferred = 0.0556 * 0.0397 = 0.0022
Weighted Cost of Equity = Cost of Equity * Market Proportion of Equity = 0.6489 *0.1185 = 0.0769

WACC = 0.0122 + 0.0022 + 0.0769 = 0.0913

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