w4/q4 similar problem WACC)As a member of the financial department of rack recor

Question

w4/q4 similar problem WACC)As a member of the financial department of rack record,your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of a new packaging equipment for the plant.Under the assumption that the firms present capital structure reflects the appropriate mix of capital sources for the firm,you have determined the market value of the firms capital structure as follows(Bonds-3,800,000,preferred stock-2,100,000,common stock-6,200,000).To finance the purchase,rack records will sell 10-year bonds paying 6.8% per year at the market price of 1,058, preferred stock paying a $2.04 dividend can be sold for $25.84.Common stock for rack record is currently selling for $54.52 per share and the firm paid a $3.09 dividend last year. dividends are expected to continue growing at a rate of 5.2% per year into the indefinite future.If the firms tax rate is 30% what discount rate should you use to evaluate the equipment purchase? Rack records WACC is _______%(round to three decimal places) Finance Finance Finance

Explanation / Answer

Total Assets of firm = Bond + Pref STock + Commn stock ie A =3800,000 + 2100000+ 6200000 = 12100000 So Weight of Debt Wd = Bond/Asset= D/A =3800,000/ $12100,000 = 32% Weght of Equity We = COmmon stock/Asset = 6200000/12100000 =51% Weight of Pref stock = 2100,000/12100,000 = 17% 10-year bonds paying 6.8% per year at the market price of 1,058 Debt: Rate Kd = Rate(nper.PMT,PV,FV) = Rate(10,68,-1058,1000) = 6% Using GOrdons Model, we have P0=D0*(1+g)/(Ks-g) So Ks = 3.09*(1+5.2%)/54.52 + 5.2% =11.16% Kp = Pref Div/Pref price = 2.04/25.84 = 7.89% We have WACC (Ka)= Wd*(Kd)*(1-t) +(We)*(Ke) + Wp*Kp where Wd= The proportion of the financing taken on by debt=32% We= The proportion of the financing provided by equity=51% Wp = Pref STock weight = 17% Kd =6% Ke = 11.16% Kp = 7.89% And WACC (Ka) = Wd*(Kd)*(1-t) +(We)*(Ke)+Wp*Kp ie wacc = 32%*6%*(1-30%) + 51%*11.16% + 17%*7.89% = 8.38%

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