You have been asked to calculate the WACC of a company that you firm is trying t

Question

You have been asked to calculate the WACC of a company that you firm is trying to value. The firm has the following element of capital: 1. Short Term Debt Market Value = $30 million; Return = 4.50% 2. Long Term Debt Par (Face Value) = $450 million; Coupon rate = 6.00%; Maturity 10 years: Current yield to maturity is 6.20% 3. Common Equity a. Class A shares (publically Traded) 30 million share outstanding; beta = 1.20; Latest Price = $22.40 b. Class B Shares (Not publically Traded) 10 million Share Outstanding; Estimated Beta = 1.40; Last Dividend Paid: $2.00 per share; Expected growth rate in dividends = 5% 4. Preferred Stock 2 million shares outstanding; Market Price = 100; Dividend Share = $5.00 Note: Do not use Floatation Cost i.e. Flotation cost = 0; Risk free rate = 2.00% and expected return on the market is 6.00%. The firm’s tax rate is 40%

Explanation / Answer

Solution.

Calculation of WACC of a company.

WACC = (Equity / Total Capital) * Cost of Equity + (Debt / Total Capital) * Cost of Debt * (1 - Tax Rate).

Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate.

= ( 2.10 / $22.40 ) + 5%

= 5.09%

Second is the Capital Asset Pricing Model (CAPM):

ra = rf + Ba (rm-rf)

= 2% + 1.40 ( 6% - 2% )

= 7.6%

Sl.No. Type   Value Weight Cost of capital WACC 1 Short Term Debt 30                0.0575 2.70% 0.0016 2 Long Term Debt 450                0.8621 3.72% 0.0321 3 Class A shares 30                0.0575 5.09% 0.0029 4 Class B Shares 10                0.0192 7.60% 0.0015 5 Preferred Stock 2                0.0038 5% 0.0002 522                0.9962        0.04

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