Peet\'s Coffee is considering a new project. It has a target capital structure o
ID: 2618204 • Letter: P
Question
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 $35.45.
Peet's has retained earnings they will use to finance their project. They estimate their cost of equity using the CAPM approach. Their beta is 1.4, the risk-free rate is 2.2% and the expected market return is 7.8%. If they have a tax rate of 35.0%, what is the WACC for this project?
Explanation / Answer
First of all lets find cost od debt ie YTM
YTM = Interest + ( Face value - current selling price)/n / ( Face value + current selling price)/2
Interest = 1000*8.5%/2 = 42.5$ , n = 16*2 = 32 , Face value = $1000 m Selling price = 985.45$
YTM = 42.5 + (1000-985.45)/32 / (1000+985.45)/2
=42.5 + 0.4547 / 992.725
=42.95469/992.725
=0.043269
Thus Annaulized YTM = 4.3269%*2 = 8.6539%
After tax cost of debt = 8.6539%(1-0.35)
=8.6539%(0.65)
=5.625%
Cost of preference = Dividend/Current stock price
=6/35.45
=16.93%
Cost of equity = Risk free rate of return + beta( Risk premium)
=2.2%+1.4(7.8%-2.2%)
=2.2%+1.4(5.6%)
=2.2%+7.84%
=10.04%
Statement showing WACC
Source of capital Weight K WACC=W*K equity 45% 10.04% 4.518% preference 5% 16.93% 0.847% debt 50% 5.63% 2.813% 8.177%Related Questions
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