5. Sound Systems (SS) has 200,000 shares of common stock outstanding at a market
ID: 2781843 • Letter: 5
Question
5. Sound Systems (SS) has 200,000 shares of common stock outstanding at a market price of $37 a share. SS recently paid an annual dividend in the amount of $1.20 per share. The dividend growth rate is 4 percent. SS also has 4,500 bonds outstanding with a face value of $1,000 per bond that are selling at 99 percent of par The bonds have a 6 percent coupon and a 6.7 percent yield to maturity. If the tax rate is 34 percent, what is the weighted average cost of capital? 6. Define "market risk" and "company specific risk" (5 points)Explanation / Answer
5.
Find the cost of equity:
According to dividend-discount model,
P0 = D1/(R-G)
P0 = Current stock price
D1 - Dividend at t =1
R - Required rate
G - Growth rate
37 = 1.2*1.04/(R-0.04)
R = 0.0737 = 7.37%
Cost of debt = YTM = 6.7%
Value of equity = 200000*37 = 7400000
Value of debt = 4500*990 = 4455000
Total value = 7400000 + 4455000 = 11855000
WACC = rD (1- Tc )*( D / V )+ rE *( E / V )
Where...
rD = The required return of the firm's Debt financing
(1-Tc) = The Tax adjustment for interest expense
(D/V) = (Debt/Total Value)
rE= the firm's cost of equity
(E/V) = (Equity/Total Value)
WACC = 7400000/11855000 * 0.0737 + 4455000/11855000 * 0.067 * (1-0.34) = 0.0626
WACC = 6.26%
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