The Saunders Investment Bank has the following financing outstanding. 50,000 bon

Question

The Saunders Investment Bank has the following financing outstanding.

  

50,000 bonds with a coupon rate of 8 percent and a current price quote of 108.0; the bonds have 20 years to maturity. 220,000 zero coupon bonds with a price quote of 21.0 and 30 years until maturity.

140,000 shares of 6 percent preferred stock with a current price of $77, and a par value of $100.

2,500,000 shares of common stock; the current price is $63, and the beta of the stock is 1.40.

The corporate tax rate is 35 percent, the market risk premium is 6 percent, and the risk-free rate is 3 percent.

  

The Saunders Investment Bank has the following financing outstanding.

Explanation / Answer

Cost of Common Stock=Rf+Beta(Rm-Rf)

=3%+(1.40*6)= 11.40%

YTM of 8% Bond=6.35%

Cost of 8% Bond (After tax)= 6.35%*.65= 4.13%

YTM of Zero Coupon Bond= 5.34%

Cost of Zero Coupon Bond(After tax)=5.34%*.65=3.48%

Cost of Pref. Stock=6%

WACC= 10.65%

Source No. Price/ Market Value Weight Cost % WACC Common Stock 2500000 $63.00 $157,500,000.00 0.88 11.40 10.07 Pref. Stock 140000 $77.00 $10,780,000.00 0.06 6.00 0.36 8% Bond 50000 $108.00 $5,400,000.00 0.03 4.13 0.13 Zero Coupon Bond 220000 $21.00 $4,620,000.00 0.03 3.48 0.09 $178,300,000.00 1.00 10.65

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