2. Given Delta Weighted Average C Company\'s Corporate Tax Rate is 40%. Ita Corp
ID: 2804125 • Letter: 2
Question
2. Given Delta Weighted Average C Company's Corporate Tax Rate is 40%. Ita Corporation's current capital structure and market conditions, what is the Companys hethe Delta has one debt issue... 100,000 Senior Bonds Current Market Price of the Senior Bonds is 95% of Face Value Yield to Maturity on the Senior Bonds is 7.70% Delta has one preferred issue.. 400,000 shares of Series A 7.00% Preferred Stock Current Preferred Stock Price is $60.00 2 Delta's Common Stock characteristics... 6,000,000 Common Shares Outstanding Current Share Price is $33 of Delta Corporation Common Stock is 1.5 US Short-Term Treasury Bills are Yielding 2.75% Current Market Risk Premium is 12.00%Explanation / Answer
Cost of debt = (1-t)*kd = (1-40%)*7.7% = 4.62%
Cost of preferred stock = Dividend/market price
Dividend = 7% of par value = 7% of 100 = $7. Thus cost of preferred stock = 7/60 = 11.67%
Cost of equity is computed using the CAPM model. Thus cost of equity = risk free rate+beta*market risk premium
= 2.75%+(1.5*12%) = 20.75%
Next step is to compute the weight of each component. Market value of bonds = 95% of face value (which I am taking as $1,000). Thus market value of bonds = 100,000 bonds*$1,000*95% = $95,000,000
Market value of preferred shares = 400,000 shares*$60 = $24,000,000
Market value of common stock = 6,000,000*$33 = 198,000,000
Total capital = 95,000,000+24,000,000+198,000,000 = $317,000,000. Weight of debt = 95000000/317000000 = 29.97%. Similarly weight of preferred stock = 7.57% and of equity = 62.46%
WACC = weight of debt*after tax cost of debt + weight of preferred shares*cost of preferred shares + weight of common stock*cost of common stock
= 29.97%*4.62 + 7.57%*11.67 + 62.46%*20.75
= 15.23%
The purpose of WACC is that it can be used as an investment tool as a hurdle rate. It can be used for ROIC computations and EVA computations. To put in simple words WACC is nothing but the minimum rate of return that a company should earn at a minimum in its investments so as to be able to generate value for the investors.
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