Fair and Equitable has to determine its cost of capital using the following info
ID: 2700126 • Letter: F
Question
Fair and Equitable has to determine its cost of capital using the following information:
The firm has $30,000,000 in corporate bonds currently selling at 97.5. The bonds mature in 9 years and have an annual coupon rate of 6.6% paid semiannually. F&E faces a 35% tax rate. This firm has 1,500,000 shares of preferred stock that pays a dividend of $0.80 per year and currently sells for $9.00 per share.
Common stock selling for $3.45 per share has just paid a dividend of $0.29 and is expected to grow by 4% forever. The firm has a beta of 1.3 and the risk free rate on treasury securities is 3%. The average return on the S&P500 is 10.54%.
Calculate the cost of capital for the firm. Fair and Equitable has 20 million common shares outstanding.
Explanation / Answer
A) PV = 97.5, N= 9*2 = 18 , PMT =3.3,FV = 100
r (semi annually) =3.48
r (annually) = 6.97
r after tax = 0.65 * 6.97 = 4.5305
pr stock r = 0.8/9 = 8.88
common stock , 3.45 = 0.29/(r- 0.04)
r = 12.4
total value = 30000000 + 13500000+ 69000000 = 112500000
w1(corporate) = 30000000/112500000 = 0.266
w2(pr stock) = 13500000/112500000 = 1.12
w3(common stock) = 69000000/112500000 = 0.6133
WACC = 0.266*4.5305 + 0.12* 8.88 + 0.6133 * 12.4
= 9.87% (approx)
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