Zhou Bakery has 5.5 million shares of common stock outstanding selling for $20 p

Question

Zhou Bakery has 5.5 million shares of common stock outstanding selling for $20 per share on the market. Zhou has preferred stock outstanding with a market value of $14 million. The bakery maintains a beta of 1.2, and the risk free rate and market risk premium are 4% and 8.33%, respectively. The bakery also has 22,000 bonds selling for 90% of face value- the bonds mature in 15 years and have a coupon rate of 7.5%; interest is paid annually. Total preferred dividends are $1.4 million. Find the WACC for Zhou if the tax rate is 35%

Explanation / Answer

Calculation of WACC using below formula :

WACC = E /(E+D+P) × re + D / (E+D+P) ×(1-t)× rd + P/(E+D+P) × rp

Where,

E= market value of equity

D= market value of debt

P= market value of preferred stock

re= cost of equity

rd= cost of debt

rp= cost of preferred stock

t= marginal tax rate

1.Let's firs calculate cost of equity using CAPM method

re = rf + B× (rm - rf)

re = 0.04 + 1.2 ( 0.0833 - 0.04 )

re= 9.20 %

2.calculate cost of preferred stock

Cost of preferred stock = Annual dividend on preferred stoc / current market price of preferred stock

Cost of preferred stock = 1.4 million / 14 million = 10%

3. Calculation of market value of debt / bond

Assume face value is $ 100, bond , face value of bond = 22,000×100 = 2.2 million

Market value of bond = F/(1+r)^t = 2.2 million /( 1 + 0.075 )^ 15 = 2.2 million / 2.96 = 0.75 million

4. Calculation of WACC using formula mention in the I tial stage

WACC = 110 /(110+0.75+14)×0.092 + 0.75/(110+0.75+13)×(1-0.35)×0.075 + 14/(110+0.75+14) ×0.10

WACC= 9.58 + 0.12 + 1.12 = 10.82

Related Questions

Navigate

• Browse (All)
• Browse Z
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.