Merrill Lynch Limited has the following information and a tax rate of 30 percent
ID: 2713774 • Letter: M
Question
Merrill Lynch Limited has the following information and a tax rate of 30 percent. .
Debt
2,000, 6 percent coupon bonds outstanding, $1,000 par value, 12 years to maturity, selling for 95 percent of par, the bonds make semiannual payments
Common stock
250,000 shares outstanding, selling for $55 per share; the beta is 1.20
Preferred stock
12,000 shares of 6 percent preferred stock outstanding, currently selling for $110 per share
Market
6 percent market risk premium and 4 percent risk-free rate
Determine the company’s WACC by computing the following:
(a) Total Market Value for the company
(b) After-tax Cost of Debt.
(c) Cost of Common Stock
(d) Cost of Preferred Stock
(e) WACC
Show all workings
Debt
2,000, 6 percent coupon bonds outstanding, $1,000 par value, 12 years to maturity, selling for 95 percent of par, the bonds make semiannual payments
Common stock
250,000 shares outstanding, selling for $55 per share; the beta is 1.20
Preferred stock
12,000 shares of 6 percent preferred stock outstanding, currently selling for $110 per share
Market
6 percent market risk premium and 4 percent risk-free rate
Explanation / Answer
a) total market value of company = market value of debt + market value of equity + market value of prefered equity
= 950*2000 + 250000* 55 + 12000*110
= 16870000
b) After tax cost of debt
K =Nx2
BOND PRICE= [(Semi-annual Coupon)/(1 + YTM/2)^k] + Par value/(1 + YTM/2)^(Nx2)
k=1
K= 12x2
950= [(6*1000/(100*2))/(1 + YTM/200)^k] + 1000/(1 + YTM/200)^12x2
k=1
YTM = 6.61%
After tax cost of debt = YTM*(1 - tax rate) = 6.61*(1 - 0.3) = 4.627%
c ) Cost of Common Stock
expected return = risk-free rate + beta * (market risk premium)
= 4 + 1.2* 6 = 11.2%
(d) Cost of Preferred Stock = Prefered perpetual payment / price = 6/110 = 5.45%
e)
WACC
=
E
×
re
+
D
×
(1 t)
×
rd
+
P
×
rp
(E+D+P)
(E+D+P)
(E+D+P)
Where:
E
=
Market value of equity
D
=
Market value of debt
P
=
Market value of preferred stock
re
=
Cost of equity
rd
=
Cost of debt
rp
=
Cost of preferred stock
t
=
Marginal tax rate
Wacc = 4.627* 950*2000/16870000 + 11.2*250000* 55/16870000 + 5.45*12000*110/16870000
= 10.0765%
WACC
=
E
×
re
+
D
×
(1 t)
×
rd
+
P
×
rp
(E+D+P)
(E+D+P)
(E+D+P)