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a) Bella industry (Bella) is seeking your financial advice to determine the firm;s cost of capital
a) Bella industry (Bella) is seeking your financial advice to determine the firm;s cost of capital. The following data is given to you
I) 20 years bond with 12% coupon was issued 10 years ago and is currently selling at RM1153.00. the firm's tax bracket is 40% and flotion cost is 20% of par value. The par value is RM1000.00
II) The current of its preferred stock is RM1.13 iissued with a divident of 10% of par value of Rm1. Flotation cost is 10% of its current price.
III) Bella's stock is currently selling at RM5 per share. The expected dividend for next year is RM0.44 and it is expected to grow ar a constant rate of 5%
Calculate the after tax cost of:
a) Debt
b) Preferred stock
c) Equity
b) Calculate the weighted average cost of capital (WACC) if the ratio is as follows:
a) debt 30%
b) Preferred stock 20%
c) Equity 50%
Expert Solution
Answer : (a) Calculation the after tax cost :
Calculation of Cost of after tax debt :
Using Financial Calculator
=RATE(nper,pmt,pv,fv)
where nper is Number of years remaining to maturity i.e 10years (20 - 10)
pmt is Interest payment i.e 1000 * 12% = 120
pv is Current Market Price
= [1153 - (1000 * 20%)]
= 953
Note : pv should be taken as negative.
fv is face value i.e 1000 (Assumed)
=RATE(10,120,-953,1000)
Before tax cost of Debt is 12.861%
After tax cost of Debt = Before tax cost of debt * (1 - Tax rate )
=12.861% * (1 - 0.40)
= 7.72%
Calculation of Cost of Preferred Stock
Cost of Preferred Stock = Annual Dividend / (Current Market Price - Flotation cost)
= [1 * 10%] / [1.13 - (1.13 * 10%)]
= 0.1 / 1.017
= 0.09832841691 or 9.83%
Calculation of Cost of Equity
Cost of Common Equity = [Expected Dividend / (Market Price )] + growth rate
= [0.44 / 5 ] + 0.05
= 0.138 or 13.8%
Calculation of WACC of the Firm
WACC = (Cost of After tax Debt * Weight of Debt) + ( Cost of Equity * Weight of Equity) + (Cost of Preferred Stock * Weight of Preferred Stock)
= (7.72% * 0.30) + (9.832841691% * 0.20) + (13.8% * 0.50)
= 2.32% + 1.97% + 6.9%
= 11.18%
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