5. Bluefield Corporation has 6 million shares of common stock outstanding, 600,0
ID: 2782107 • Letter: 5
Question
5. Bluefield Corporation has 6 million shares of common stock outstanding, 600,000 shares of preferred stock that pays an annual dividend of $8, and 200,000 bonds with a 10 percent coupon (semiannual interest) and 20 years to maturity. At present, the common stock is selling for $50 per share, the bonds are selling for $950.62 per $1,000 of face value, and the preferred stock is selling at $74 per share.
The estimated required rate of return on the market is 13 percent, the risk-free rate is 8 percent, and Bluefield's beta is 1.4. Bluefield's tax rate is 30 percent. Estimate the cost of each source of financing, the weights to apply to each source, and the WACC.
Explanation / Answer
Cost of Common Equity = Risk Free Rate + Beta * (Market Return - Risk Free Rate)
= 0.08 + 1.4 * (0.13 - 0.08) = 15%
Cost of Prefered Equity = Annual Dividend / Cost of Prefered Equity = 8/74 = 10.81%
Cost of Bond = Coupon * ( 1- Tax Rate) = 0.1 * ( 1 - 0.3) = 7%
Now lets calculate the weights, which are based on Market Value of Equity and Debt
Market Value Of Equity = 6 * 50 =300 Million
Market value of prefered = 0.6 * 74 = 44.4 Million
Market value of Bond = 0.2 * 950.62 = 190.124 Million
Total Market Value = 534.524
Weight of Equity = Market Value Of Equity / Total Market Value = .56
Weight of prefered = Market value of prefered / Total Market Value = 0.08
Weight of Bond = Market value of Bond / Total Market Value = .36
Thus WACC = Weight of Equity * Cost Of Equity + Weight of prefered * Cost Of Prefered + Weight of Bond * Cost Of Bond
= 0.56 * 0.15 + 0.08 * 0.1081 * 0.36 * 0.07 = 11.78 % (Approx)
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