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You are tasked with estimating the WACC for your employer
You are tasked with estimating the WACC for your employer. There is one bond issue with 14 years to maturity, a $700,000 face value, and 7% coupon rate, payable semi-annually. The bonds' quoted price is 109.38. There are 1,000 preferred shares outstanding. Each share, with a current price of $800, pays an annual $40 dividend. There are 30,000 common shares outstanding with a current price of $50 per share. Last week, the board issued a $4.00 dividend per common share. Cash dividends are expected to indefinitely grow at 3% per year. The corporate tax rate is 25%. Calculate the WACC for the company.
A) Cost of common share equity?
B) Cost of preferred share equity ?
C) Cost of debt ?
D) Weighting of common share equity?
E) Weighted average cost of capital ?
Expert Solution
A) Computation of the cost of common share equity:-
Cost of equity = (D1 / Current price) + Growth rate
= ($4 * (1 + 3%) / $50) + 3%
= ($4.12 / $50) + 3%
= 8.24% + 3%
= 11.24%
B) Computation of the preferred share equity:-
Preferred share equity = Annual dividend / Preferred share price
= $40 / $800
= 5%
C) We can calculate cost of debt by using the following formula in excel:-
=rate(nper,pmt,-pv,fv)
Here,
Rate = Cost of debt (semiannual)
Nper = 14*2 = 28 periods
Pmt = Coupon payment = $1,000*7%/2 = $35
PV = $1,000*109.38% = $1,093.80
FV = $1,000
Substituting the values in formula:
= rate(28,35,-1093.80,1000)
= 3.00%
Cost of debt = Rate * 2
= 3.00% * 2
= 6.00%
D) Computation of the weight of common share equity:-
Value of debt = $700,000 * 109.38%
= $765,660
Value of common share equity = 30,000 * $50
= $1,500,000
Value of preferred share equity = 1,000 * $800
= $800,000
Total value = $765,660 + $1,500,000 + $800,000
= $3,065,660
Weight of debt = $765,660 / $3,065,660
= 24.98%
Weight of common share equity = $1,500,000 / $3,065,660
= 48.93%
Weight of preferred equity = $800,000 / $3,065,660
= 26.10%
E) Computation of the weighted average cost of capital (WACC):-
WACC = (Weight of debt * After tax cost of debt) + (Weight of common share equity * Cost of common equity) + (Weight of preferred equity * Cost of preferred equity)
= (24.98% * 6.00% * (1 - 35%)) + (48.93% * 11.24%) + (26.10% * 5.00%)
= 0.97% + 5.50% + 1.30%
= 7.78%
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