Debt: 5,500 7.5 percent coupon bonds outstanding, $1,000 par value, 19 years to

Question

Debt: 5,500 7.5 percent coupon bonds outstanding, $1,000 par value, 19 years to maturity, selling for 104 percent of par; the bonds make semiannual payments.

Common stock: 132,000 shares outstanding, selling for $59 per share; the beta is 1.07.

Preferred stock: 18,500 shares of 6.5 percent preferred stock outstanding, currently selling for $106 per share.

Market: 8.5 percent market risk premium and 6 percent risk-free rate.

Assume the company's tax rate is 32 percent.

Assume the company's tax rate is 32 percent.

Explanation / Answer

Note: Each calculation is rounded off to two decimal places.

Cost of debt:

P0 = 1000x(104%) = $1040

Coupon = 1000x7.5%x0.50 = $37.50

T = 38

R= 3.56%

YTM = 3.56x2 = 7.12%

After tax cost of debt = 7.12(1-0.32) = 4.84%

Cost of equity:

Ke = Rf + (Beta x Risk premium)

= 6 + (1.07 x 8.5)

= 15.10%

Cost of preferred stock (Kp) = 6.5/106 x 100 = 6.13%

WACC = [Cost of debt x Weight of debt] + [Cost of equity x Weight of equity] + [Cost of preferred stock x Weight of preferred stock]

= [4.84 x (5500x1040/15469000)] + [15.10 x (132000x59/15469000)] + [6.13 x (18500x106/15469000)]

= 1.79 + 7.60 + 0.78

= 10.17%

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