The Saunders Investment Bank has the following financing outstanding. Debt: 60,0

Question

The Saunders Investment Bank has the following financing outstanding. Debt: 60,000 bonds with a coupon rate of 6 percent and a current price quote of 109.5; the bonds have 20 years to maturity. 230,000 zero coupon bonds with a price quote of 17.5 and 30 years until maturity. Preferred stock: 150,000 shares of 4 percent preferred stock with a current price of $79, and a par value of $100. Common stock: 2,600,000 shares of common stock; the current price is $65, and the beta of the stock is 1.15. Market: The corporate tax rate is 40 percent, the market risk premium is 7 percent, and the risk-free rate is 4 percent. What is the WACC for the company?

Explanation / Answer

Step 1:

1) Cost of Common Stock = Rf + (Rm-Rf)*Beta

Cost of Common Stock = 4 + 7*1.15

Cost of Common Stock = 12.05%

2) Cost of Preferred Stock = 4/79

Cost of Preferred Stock = 5.06%

3)

Coupon Bond

Before Tax Cost of Debt = rate(nper,pmt,pv,fv)

Before Tax Cost of Debt = rate(20,60,-1095,1000)

Before Tax Cost of Debt = 5.22 %

After Tax Cost of Debt = 5.22*(1-40%)

After Tax Cost of Debt = 3.13%

Zero Coupon Bond

Before Tax Cost of Debt = rate(nper,pmt,pv,fv)

Before Tax Cost of Debt = rate(30,0,-175,1000)

Before Tax Cost of Debt = 5.98 %

After Tax Cost of Debt = 5.98*(1-40%)

After Tax Cost of Debt = 3.59%

Step 2:

Market Value of Common Stock = 2600000*65 = 169,000,000

Market value of Preferred Stock = 150000 * 79 = $ 11,850,000

Market Value of Coupon Bond = 60000*1095 = $ 65,700,000

Market Value of zero Coupon Bond = 230000*175 = $ 40,250,000

Total Market Value = 286,800,000

Weight of Common Stock = 169/286.8

Weight of Preferred Stock = 11.85/286.8

Weight of coupon Bond = 65.7/286.8

Weight of Zero coupon Bond = 40.25/286.8

Step3:

WACC = Weight of Common Stock* Cost of Common Stock + Weight of Preferred Stock* Cost of Preferred Stock + Weight of CouponBond* After Tax cost of Coupon Bond + Weight of Zero CouponBond* After Tax cost of Zero Coupon Bond

WACC = 169/286.8* 12.05 + 11.85/286.8*5.06 + 65.7/286.8*3.13+ 40.25/286.8*3.59

WACC = 8.53%

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