XYZ has target capital structure of 60% common stock, 30% debt and 10% preferred

Question

XYZ has target capital structure of 60% common stock, 30% debt and 10% preferred stock. The company wishes to issue new 30 years bond with 10% coupon rate. The flotation cost will be $20 and the bond has to be sold at 5% discount. To issue new preferred stock the company has to pay $2 as flotation cost. The market value of preferred stock is $8 and the stock will pay $1 dollar dividend. New common stock will cost the company $2. The expected dividend is $3 and the market value is $19. Tax rate is 40%. What is the company

Explanation / Answer

Let Bond face value = 1000

Bond issue price = 1000-5%*1000 = 950

FLoatation cost = 20

Coupon = 10%

So PMT = 10%*1000 = 100

nper = 30

Bond floatation cost is an issue expense & wont affect Yield. It will only affect no of bonds issued.

So Yield = Rate(nper,pmt,PV,FV)

= Rate(30,100,-950,1000)

Kd= 10.56% ............(A)

Return on Pref Share = Kp = Pref Div/(Pref Price-Float cost)

= $1/($8-$2)=16.67%

COmmn stock price P0=19, D1=3, g is not given. If you have missed it, pl use that in below formula to get new Ks. Rest steps will be same.

So Ks = g + D1/(Po-f) = 3/(19-2) = 17.65%

So WACC (Ka)= Wd*(Kd)*(1-t)+(Wp)*(Kp) +(We)*(Ke)

where Wd= The proportion of the financing taken on by debt=30%

Wp= The proportion of the financing taken provided by preferred stock=10%

We= The proportion of the financing provided by equity=60%

Kp= 16.67%

Kd=10.56%

Ke (Using CAPM) = 17.65%

T=40%

And WACC (Ka) = Wd*(Kd)*(1-t)+(Wp)*(Kp) +(We)*(Ke)

ie wacc = 30%*10.56%*(1-40%) + 10%*16.67% + 60%*17.65%

ie WACC = 14.16%

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