Important Note : For any weight calculation, use 4 decimal points (e.g. wd=0.152
ID: 2645973 • Letter: I
Question
Important Note: For any weight calculation, use 4 decimal points (e.g. wd=0.1525). For any rate of return of cost component calculation, use 2 decimal points (e.g. Kd=5.25%).
The company?s existing bonds sell for $895, have 8% coupon rate with semi-annual payments and 10 years to maturity.
The company?s current preferred stock pays $2.5 preferred dividends every six months. The market price of the preferred stock is $95.
The market price of the common stock is $6. The next expected dividend is $1.25, and the dividends are expected to grow at 5% forever.
The company?s tax rate is 35%.
A) What are the market weights of this company?s capital structure?
B) What is the current WACC for this company using market weights of capital structure?
Assets $40 SA0 Current Net Fixed Total 60 $100 Bonds (S1000 par) Preferred Stock ($100 par) 5 Common Stock ($2 par) 50 Total 45 $100Explanation / Answer
a) Market weights will be = amount of capital component/totao capital
Total capital = $100
Weight of bonds = amount of bonds/total capital = 45/100 = 45.0000%
Weight of preferred stock = amount of preferred stock/total capital = 5/100 = 5.0000%
Weight of common stock = 50/100 = 50.0000%
b) WACC = cost of bond*weight of bond+cost of preffered stock*its weight+ cost of common stock*its weight
Cost of bonds = 8%. after tax cost of bonds = (100-35%)*8 = 5.2%
Dividends on preferred stock = 2.5+2.5 = $5 in a year
its cost = dividend/market price = 5/95 = 0.052 or 5.2%
Dividends on common stock = 1.25
its cost = dividend/market price = 1.25/6 = 0.208 = 20.83%
Weighted average cost of capital (using formula mentioned earlier) = 0.45*5.2+.05*5.2+0.5*20.83
= 2.34+0.26+10.42
= 13.02%