Cash 80 AR 240 Inventories 320 Current Assets 640 Fixed Assets 480 Total Assets
ID: 2710167 • Letter: C
Question
Cash 80
AR 240
Inventories 320
Current Assets 640
Fixed Assets 480
Total Assets 1120
AP 120
Accruals 100
Short Term Debt 40
Current Liabilities 260
Long Term Debt 200
Preferred stock 40
Common stock 200
Retained Earnings 420
Total Common Equity 620
Total debt and equity 1120
Short term debt is fully repaid at least once a year. Long term debt is 20 year, semi annual payment bonds with a coupon rate of 8%. The current rate on XYZ quality debt is 11% Preferred stock with a $100 par value pays quarterly dividend of 2.5%. The preferred stock currently has a yield of 13%. New preferred stock would require the same 13% yield to investors and the company would incur a 5% flotation cost to sell it. The company has 6 million share outstanding with a price of $480. The dividend in 2014 was $32. Management expects the dividend to grow 10% over the foreseeable future. The risk free rate is 6%. The market premium is 6%. The estimated beta for XYZ is 1.2. The tax rate for XYZ is 40%.
What is the WACC for XYZ?
Explanation / Answer
WACC = r(E) × w(E) + r(D) × (1 – t) × w(D) + r(PS) x w(PS)
E = equity, D=debt, PS=preferred stock
cost of equity = risk free rate + beta*market premium
hence, r(E) = 6% + 1.2*6% = 13.2%
r(PS) = 13%
r(D) = 11%
Now to we must find out weight of each component:
Total common equity 480*6 = 2880, Total Debt = 240 (unsure of the market value, feel free to change this), PS = 40 (total capital = 3160)
w(E) = 2880/3160 = 0.91, w(D) = 240/3160=0.08, w(PS)=0.01
w(E) is the weight of equity in the company’s total capital. It is calculated by dividing the market value of the company’s equity by sum of the market values of equity and debt.
w(D) is the weight of debt component in the company’s capital structure. It is calculated by dividing the market value of the company’s debt by sum of the market values of equity and debt.
WACC = 12.67% simply plug the numbers in formula, check for the market value of debt..