value debt outstanding. The 9 percent coupon bonds (ser of 15 years and are curr
ID: 2787166 • Letter: V
Question
value debt outstanding. The 9 percent coupon bonds (ser of 15 years and are currently priced at $1/440.03 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $12.00. The preferred shares offer an annual dividend of $1.20, Imaginary also has 14 million shares of common stock outstanding with a price of $20,00 per share. The firm is expected to pay a $2 20 common dividend one year from today, and that dividend is expected to increase by 5 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, pay) have a maturity t of capital? Capital component Bonds Preffered stock Common stock Number outstanding 300,000 Current price 2,000,000 s 14 000,000 s 2 1.440.03 12.00 20.00 Coupon rate on debt Coupon frequency (per year) Bond maturity (years) 9% 15 $1120 $2.20 Expected dividend on common (D:) stant annual dividend growth rate fforever) 40% n stock conia marletlueExplanation / Answer
Debt:
Number of Bonds Outstanding = 300,000
Current Price of Bond = $1,440.03
Market Value of Debt = $1,440.03 * 300,000
Market Value of Debt = $432,009,000
Face Value of Bond = $1,000
Semi-annual Coupon = 4.50%*$1,000 = $45
Semi-annual Period to Maturity = 30
Let semi-annual YTM be i%
$1,440.03 = $45 * PVA of $1 (i%, 30) + $1,000 * PV of $x (i%, 30)
Using spreadsheet, i = 2.42%
Semi-annual YTM = 2.42%
Annual YTM = 4.84%
Before-tax Cost of Debt = 4.84%
After-tax Cost of Debt = 4.84%*(1-0.40)
After-tax Cost of Debt = 2.904%
Preferred Stock:
Number of Preferred Stock = 2,000,000
Current Value = $12.00
Market Value of Preferred Stock = $12.00 * 2,000,000
Market Value of Preferred Stock = $24,000,000
Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $1.20 / $12.00
Cost of Preferred Stock = 10%
Common Stock:
Number of Common Stock = 14,000,000
Current Value = $20.00
Market Value of Common Stock = $20.00 * 14,000,000
Market Value of Common Stock = $280,000,000
Cost of Common Stock = D1 / P0 + g
Cost of Common Stock = $2.20 / $20.00 + 5%
Cost of Common Stock = 16.00%
Total Market Value of Firm = Market Value of Debt + Market Value of Preferred Stock + Market Value of Common Stock
Total Market Value of Firm = $432,009,000 + $24,000,000 + $280,000,000
Total Market Value of Firm = $736,009,000
Weight of Debt = $432,009,000 / $736,009,000
Weight of Debt = 0.5870
Weight of Preferred Stock = $24,000,000 / $736,009,000
Weight of Preferred Stock = 0.0326
Weight of Common Stock = $280,000,000 / $736,009,000
Weight of Common Stock = 0.3804
WACC = Weight of Debt*After-tax Cost of Debt + Weight of Preferred Stock*Cost of Preferred Stock + Weight of Common Stock*Cost of Common Stock
WACC = 0.5870*2.904% + 0.0326*10% + 0.3804*16%
WACC = 8.12%
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