Consider the after-tax cash flows below from a project that is being considered
ID: 2731851 • Letter: C
Question
Consider the after-tax cash flows below from a project that is being considered by Despondus Corportation. Since the project is an extension of the firm's current business, it carries the same risk as the overall firm.
Despondus Corporation's common stock is currently priced at $44.62, and there are 684,000,000 shares outstanding. A dividend of $3.73 per share was just paid and dividends are expected to grow at a constant rate of 5.87% per year. The company has 7,300,000 bonds outstanding that mature in 10 years and are currently prices at 1,015 per bond. The coupon rate is 14.48%, and the bonds make semiannual interest payments. The company's tax rate is 34%.
What is Despondus Corporation's weighted average cost of capital (WACC)?
Correct Answer:
14.698510% x .804651 + 9.368486% x .195349 = 13.66%
MY QUESTION: Where did they get these numbers to solve for this equation. I do not understand how to solve for this.
YEAR -251,000 94000 65000 112000 94000 104000 CASH FLOWS 0 1 2 3 4 5Explanation / Answer
Solution: Formula of WACC (Ke*We)+(Kd*Wd) Where Ke = Cost of equity We= Weight of equity Kd= After tax cost of debt Wd= Weight of debt Ke as per dividend growth model (D1/P0)+g Where D1 = Dividend to be paid in next year (3.73*105.87%) = 3.95 Po = Current market price of stock g = Growth rate (3.95/44.62)+0.0587 14.72% Since bonds make a payment of interest in semi annual instalment hence effective annual interest rate needs to be calculated by following formula =[POWER(1+r,1/m)]-1 K = effective rate of interest K =[POWER(1+0.1448,1/2)]-1 r = Rate of interest = 7.99% per half year or 14% per year m = No. of payments during the year Calculation of After tax cost of debt Kd*(1-t) Kd = cost of debt i.e. 14% 14*(1-0.34) t = Tax rate 9.24% Calculation of weight of equity and debt Particulars No. of security outstanding Market price Market value Weight Stock 6.84E+08 44.62 30520080000 0.80465115 Bonds 7300000 1015 7409500000 0.19534885 37929580000 1 Calculation of WACC as per above formula = (14.72*.804651)+(9.24*0.195349) = 13.65%