The Saunders Investment Bank has the following financing outstanding. 50,000 bon
ID: 2799128 • Letter: T
Question
The Saunders Investment Bank has the following financing outstanding.
50,000 bonds with a coupon rate of 8 percent and a current price quote of 108; the bonds have 20 years to maturity. 220,000 zero coupon bonds with a price quote of 21 and 30 years until maturity. Assume semiannual compounding.
140,000 shares of 6 percent preferred stock with a current price of $77, and a par value of $100.
2,500,000 shares of common stock; the current price is $63, and the beta of the stock is 1.4.
The corporate tax rate is 35 percent, the market risk premium is 6 percent, and the risk-free rate is 3 percent.
The Saunders Investment Bank has the following financing outstanding.
Explanation / Answer
Using CAPM,
Cost of equity ke = Rf + beta x MRP = 3% + 1.4 x 6% = 11.40%
Cost of preferred stock, kps = Dividend / Price = 6% x 100 / 77 = 7.79%
Cost of coupon bond can be calculated using I/Y function
N = 20 x 2 = 40, PMT = 8% x 100 / 2 = 4, PV = -108, FV = 100 => Compute I/Y = 3.62% (semi-annual)
Cost of debt 1, kd1 = 2 x 3.62% = 7.24%
Cost of zero coupon bond, kd2 = ((100 / 21)^(1/30*2) - 1) x 2 = 5.27%
Market Value of equity = 2,500,000 x 63 = 157,500,000
Market Value of preferred stock = 140,000 x 77 = $10,780,000
Market Value of Coupon Bond = 50,000 x 1,080 = 54,000,000
Market Value of Zero Coupon Bond = 220,000 x 210 = $46,200,000
Total market Value = $268,480,000.
Weight of equity, we = 157,500,000 / 268,480,000 = 58.66% and similalry,
wps = 4.02%, wd1 = 20.11% , wd2 = 17.21%
WACC = we x ke + wps x kps + (wd1 x kd2 + wd2 x kd2) x (1 - tax rate) = 8.54%
Value Weight Cost Equity $ 157,500,000 58.66% 11.40% P.S. $ 10,780,000 4.02% 7.79% Debt 1 $ 54,000,000 20.11% 7.24% Debt 2 $ 46,200,000 17.21% 5.27% Total $ 268,480,000 WACC 8.54%Related Questions
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