2. JS Inc. has been financed using both debt and equity. The company has outstan

Question

2. JS Inc. has been financed using both debt and equity. The company has outstanding a 20-year, $1,000,000 par value bond that was issued in 2005 and that carries a 10% coupon rate, and tomorrow, a 20-year bond with a par value of $1,000,000 carrying a coupon rate of 8% will be issued. JS has preferred stock outstanding (25,000 shares, market price = $75) with a dividend yield of 5.5%. JS has issued 100,000 shares of common stock, and its most recent market price was $32.50 per share. Presently, the T-bill rate is 4%, and analysts have estimated that the market will return its historical average, which is 12%. The most recent S&P report on JS Inc. listed a beta of .95. The company’s tax rate is 40%, and the company uses wacc as its discount rate for projects. What is the WACC for JS Inc.? Current Year: 2010

Explanation / Answer

(i) Cost of debt (kd) Price of both the bonds is same i.e. at PAR Also If bond is issued at par its coupon rate = Its YTM Therefore cost of debt = YTM x (1-t) old(Kd0) new(kdn) YTM 10% 8% Post tax Cost of debt 6.00% 4.80% Market value 1000000 1000000 (ii) Cost of prefered stock(kp) = Dividend/ Price x 100 Dividend = 75 x 5.5% x 25000= 23375 Market price = 75 x 25000 = 1875000 Cost of prefered stock = 1.2467% (iii) Cost of common stock (Ke) - Rf + (Rm- Rf) x B= 4 + (12-4) x 0.95 = 0.08 Market value = 100000 x 32.5 = 3250000 WACC = Security Market value Cost W x C (w) (c ) Old bond 1000000 0.06000 60000 New bond 1000000 0.04800 48000 Preferred stock 1875000 0.01247 23375 Common stock 3250000 0.07640 248300 7125000 379675 WACC = SUM(WC/W) x 100 = 379675/7125000 x 100 5.3288% Please provide feedback……... thanks in advance……… :-)

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