D | Question 22 3 pts Peet\'s Coffee is considering a new project. It has a targ

ID: 2618138 • Letter: D

Question

D | Question 22 3 pts Peet's Coffee is considering a new project. It has a target capital structure of 50% debt, 45% equity and 5% preferred stock. Peet's has noncallable bonds outstanding, with a coupon rate of 8.5% (paid semiannually), that mature in 16 years with a face value of $1,000, and a market price of $985.45. The yield on the company's current bonds is a good approximation of the yield on any new bonds they issue. The company can sell shares of preferred stock that pay an annual dividend of $6 at a price of $35.45 Peet's has retained earnings they will use to finance their project. They estimate their cost of equity using the CAPM approach. Their beta is 1.4, the risk-free rate is 2.2% and the expected market return is 7.8%. If they have a tax rate of 35.0%, what is the WACC for this project? o 10.7% ? 82% 13.7% C95%

Explanation / Answer

Correct option is > 8.2%

Working:

Cost of debt before tax:

Using financial calculator BA II Plus - Input details:

FV = Face Value at maturity =

-$1,000.00

PV = Present Value or Price of the bond =

$985.45

N = Total holding period in years = 16 x 2 =

PMT = Coupon Payment = FV x Coupon /2 =

-$42.50

CPT > I/Y = Rate or yield semi-annual =

4.3349

Convert semi-annual yield to annual yield in % = I/Y x 2/100 =

8.67%

Cost of preferred stock:

Cost of preferred stock = Dividend on preferred stock / Market value of preferred stock

Cost of preferred stock = 6 / 35.45

Cost of preferred stock = 16.93%

Cost of equity:

CAPM equation below;

Cost of equity = Risk free rate + Beta x (Return on Market – Risk free rate)

Cost of equity = 2.2% + 1.4 x (7.8% - 2.2%)

Cost of equity = 10.04%

Now we can calculate WACC:

WACC = Cost of equity x weight of equity + Cost of preferred x weight of preferred + Cost debt x weight of debt x (1-Tax rate)

WACC = 10.04% x 45% + 16.93% x 5% + 8.67% x 50% x (1-35%)

WACC = 8.2%