2. A company wishes to raise funds for a project. It will use bank loan, retaine
ID: 2517125 • Letter: 2
Question
2. A company wishes to raise funds for a project. It will use bank loan, retained earnings, common stock dividends and bonds. No other sources. The total amount to be raised is 2,000,000. Bank loan will be 400,000. Retained Earnings 300,000. Bonds 800,000. The rest through common stock dividends. Income Tax rate will be 30%, Bank loan rate is 6% compounded semi-annually. Annual Earnings per share 80 cents (after taxes. And interest costs). Price of stock per share is 20.00. Ignore any growth factor. Bond rate of return is 12% annual compounded quarterly. What is the Weighted Average Cost of Capital? Show all work for full credit.Explanation / Answer
Equivalent Bank Loan Rate : [1+i/n]^n - 1
=[1+.06/2]^2 - 1
=[1+.03]^2 -1
= 1.0609 - 1
=.0609 or 6.09%
After tax cost of loan : 6.09 [1-.30] = 4.263%
Equivalent cost of Bond : [1+.12/4]^4 - 1
= [1+.03]^ 4 - 1
= 1.1255-1
= .1255 or 12.55%
After tax cost of bond ; 12.55[1-.30 ] = 8.785%
Cost of equity : Annual earnings /price
= .8/20
=.04 or 4%
Weighted average cost of capital = 5.97%
Financing Cost Market valUe Market value weights cost *Weights Bank Loan 4.263% 400000 400000/2000000= .20 4.263*.20= .8526 Bond 8.785% 800000 800000/2000000= .40 3.514 Equity 4% 800000 800000/2000000=.40 1.6 2,000,000 WACC 5.9666 [rounded to 5.97%]Related Questions
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