The Saunders Investment Bank has the following financing outstanding. 20,000 bon
ID: 2653908 • Letter: T
Question
The Saunders Investment Bank has the following financing outstanding.
20,000 bonds with a coupon rate of 10 percent and a current price quote of 108.0; the bonds have 20 years to maturity. 190,000 zero coupon bonds with a price quote of 19.5 and 30 years until maturity.
110,000 shares of 8 percent preferred stock with a current price of $83, and a par value of $100.
2,200,000 shares of common stock; the current price is $69, and the beta of the stock is 1.35.
The corporate tax rate is 40 percent, the market risk premium is 7 percent, and the risk-free rate is 4 percent.
The Saunders Investment Bank has the following financing outstanding.
Explanation / Answer
Step 1:
1) Cost of Common Stock = Rf + (Rm-Rf)*Beta
Cost of Common Stock = 4 + 7*1.35
Cost of Common Stock = 13.45%
2) Cost of Preferred Stock = 8/83
Cost of Preferred Stock = 9.64%
3) Before Tax Cost of coupon Bond = rate(nper,pmt,pv,fv)
Before Tax Cost of coupon Bond = rate(20,100,-1080,1000)
Before Tax Cost of coupon Bond = 9.12 %
Before Tax Cost of Zero coupon Bond = rate(nper,pmt,pv,fv)
Before Tax Cost of Zero coupon Bond = rate(30,0,-195,1000)
Before Tax Cost of Zero coupon Bond = 5.60 %
After Tax Cost of coupon Bond =9.12*(1-40%)
After Tax Cost of coupon Bond = 5.47%
After Tax Cost of Zero coupon Bond = 5.60*(1-40%)
After Tax Cost of Zero coupon Bond = 3.36%
Step 2:
Market Value of Common Stock = 2200000*69 = $ 151,800,000
Market value of Preferred Stock = 110000*83 = $ 9,130,000
Market Value of Coupon Bond = 20000*1080 = $ 21,600,000
Market Value of Zero Coupon Bond = 190000*195 = $ 37,050,000
Total Market Value = 219,580,000
Weight of Common Stock = 15180/21958
Weight of Preferred Stock = 913/21958
Weight of Coupon Bond = 2160/21958
Weight of Zero Coupon Bond = 3705/21958
Step3:
WACC = Weight of Common Stock* Cost of Common Stock + Weight of Preferred Stock* Cost of Preferred Stock + Weight of Coupon Bond* After Tax cost of Coupon Bond+ Weight of Zero Coupon Bond* After Tax cost of Zero Coupon Bond
WACC = 15180/21958*13.45 + 913/21958*9.64 + 2160/21958*5.47 + 3705/21958*3.36
WACC = 10.80%
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