Bob Co. has 150,000 shares of common stock outstanding. Last month, LastTest pai
ID: 2714883 • Letter: B
Question
Bob Co. has 150,000 shares of common stock outstanding. Last month, LastTest paid an annual dividend in the amount of $7.50 per share. The dividend is expected to grow g=3% every year forever. LastTest also has 19,500 bonds outstanding with a face value of $10,000 per bond. The bonds carry a 9% coupon, pay interest quarterly, and mature in 20 years. The bonds are selling at a 10% discount. The company's tax rate is 30%. The T-Bills rate is 5%, the market risk premium is 7%, and the company’s beta is 1.75. What is LastTest 's weighted average cost of capital?
Explanation / Answer
LastTest 's weighted average cost of capital :
= ke / ke + kd+ kt + kd / ke + kd+ kt + kt / ke + kd+ kt
= 0.8025 /0.8025 +21+ 0.1725 + 21 / 0.8025 +21+ 0.1725 + 0.1725 / 0.8025 +21+ 0.1725
= 0.0365 + 0.9556 + 0.0078
= 99.99%
Note: cost of equity Ke= current dividend(1+ growth rate) / current price + dividend growth rate
= $7.50(1+0.03) / $10 + 0.03
= 0.8025
Note: We assume that current price of stock is $10
Cost of Debt Kd= Interest(1-tax) / net proceed
= $2700(1-0.30) / / $90
= 21
Note: We assume that the face value of one Bond is $100
interest annually on face value = $10000 * 9% * 1/4months * 12monhts
=$2700
Net proceed after discount = 100 - (10%*100)
= $100-$10
= $90
Cost of T Bills Kt = Risk free return + Beta(Market risk premium )
= 0.05 + 1.75 (0.07)
= 0.1725