Suppose Facebook wants to raise capital to start a new project. The CEO asks you
ID: 2619909 • Letter: S
Question
Suppose Facebook wants to raise capital to start a new project. The CEO asks you to calculate their weighted average cost of capital. He gives you these facts. Their tax rate = 34%.
Facebook has a 20 year, 7.3% coupon semiannual payment non-callable bond with a face value of $1,000 that are available for $1,054.34 New bonds will be privately placed with no flotation cost.
Facebook has preferred stock that sells for $115.00 and pays a dividend of $25.
Their common stock sells for $76.50. The annual dividend is $2.35 and the dividend growth rate is 3.6% a year. The stock has a Beta of .87. The risk free rate is 1.75% and the market risk premium is 7.9%.
Facebook considers their bond-Yield Risk Premium to be 2%.
Facebook currently has 30% of their capital coming from debt, 20% from preferred stock and 50% from common equity, however their target is to have 40% from debt, 15% from preferred stock and 45% from common equity.
Show the cost of debt, the cost pf preferred stock, the average of the cost of common equity using the 3 methods we've discussed. Then show the WACC formula and the final WACC value for Facebook.
Explanation / Answer
a) Cost of Debt Face Value $1,000.00 Semiannual Coupon Rate = 7.3%/2 3.65% Semiannual Coupon payment $36.50 Period = 20 x 2 40 Current price $1,054.34 YTM = Rate(40,36.50,-1054.34,1000) 3.40% Semiannual Annual Cost of debt = 3.40% x 2 6.80% b) Cost of Preferred stock Cost of Preferred stock = $25/$115 21.74% c) Cost of Equity Cost of Equity = RF + Beta x (RM - RF) = 1.75% + .87 x 7.9% 8.62% Cost of Equity = D0 x (1 + g)/P0 + g = ($2.35 x (1 + 3.6%)/$76.50) + 3.6% 6.78% Cost of Equity = company’s own bond yield + risk premium = 6.80% + 2% 8.80% Average of Cost of Equity = (8.62% + 6.78% + 8.80%)/3 8.07% d) WACC= wd x rd(1 - T) + wps x rps + wce x (rs) WACC= 40% x 6.80% x (1 - 34%) + 15% x 21.74% + 45% x 8.07% 8.69%
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