Problem 13-17 Preferred Stock and WACC The Saunders Investment Bank has the foll
ID: 2647008 • Letter: P
Question
Problem 13-17 Preferred Stock and WACC
The Saunders Investment Bank has the following financing outstanding.
130,000 bonds with a coupon rate of 9 percent and a current price quote of 112.0; the bonds have 20 years to maturity. 300,000 zero coupon bonds with a price quote of 17.0 and 30 years until maturity.
220,000 shares of 7 percent preferred stock with a current price of $69, and a par value of $100.
3,300,000 shares of common stock; the current price is $55, and the beta of the stock is 1.00.
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
Step 1:
1) Cost of Common Stock = Rf + (Rm-Rf)*Beta
Cost of Common Stock = 3 + 6*1
Cost of Common Stock = 9%
2) Cost of Preferred Stock = 7/69
Cost of Preferred Stock = 10.14 %
3)
Coupon Bond
Before Tax Cost of Debt = rate(nper,pmt,pv,fv)
Before Tax Cost of Debt = rate(20,90,-1120,1000)
Before Tax Cost of Debt = 7.80 %
After Tax Cost of Debt = 7.80*(1-35%)
After Tax Cost of Debt = 5.07%
Zero Coupon Bond
Before Tax Cost of Debt = rate(nper,pmt,pv,fv)
Before Tax Cost of Debt = rate(30,0,-170,1000)
Before Tax Cost of Debt = 6.08 %
After Tax Cost of Debt = 6.08*(1-35%)
After Tax Cost of Debt = 3.95%
Step 2:
Market Value of Common Stock = 3.3 Million * 55 = $ 181.50 Million
Market value of Preferred Stock = 0.22 Miillion * 69 = $ 15.18 Million
Market Value of coupon Bond = 0.13 Million * 1120 = $ 145.60 Million
Market Value of Zero coupon Bond = 0.3 Million * 170 = $ 51 Million
Total Market Value = 393.280
Weight of Common Stock = 181.50/393.280
Weight of Preferred Stock = 15.18/393.280
Weight of coupon bond Debt = 145.60/393.280
Weight of zero coupon bond Debt = 51/393.280
Step3:
WACC = Weight of Common Stock* Cost of Common Stock + Weight of Preferred Stock* Cost of Preferred Stock + Weight of coupon bond Debt* After Tax cost of coupon bond Debt + Weight of zero coupon bond Debt* After Tax cost of zero coupon bond Debt
WACC = 181.50/393.280*9 + 15.18/393.280*10.14 + 145.60/393.280*5.07+ 51/393.280*3.95
WACC = 6.93%