Canyon Electronics has a 8 million shares of common stock outstanding, and 100,0

Question

Canyon Electronics has a 8 million shares of common stock outstanding, and 100,000 7.5 semiannual bonds outstanding, par value $ 1,000 each. The bonds have 12 years to maturity and sell for 90 percent of par. The company uses the constant growth model to determine the cost of equity. The company's common stock currently trades at $ 30 per share. The year-end dividend is expected to be $ 4 per share, and the dividend is expected to grow forever at a constant rate of 5 percent a year. The company's tax rate is 30 %. a) what is the company's cost of debt? b) what is the company's cost of equity? c) what is the company's wacc?

Explanation / Answer

Given:

Bond:

100000, 7.5 Bond @ par value of $1000

Bond sale value @90% of Par Value = $900

Equity:

8000000 Shares Current Mkt Price $30

Expected Dividend=$4/share

Constant growth @ 5%

Tax rate 30%

Cost of Debt:

Cost of debt = Pre-tax cost of firm's bonds or short-term debt (1 - marginal tax rate)

            =7.5%(1-.30) = 5%

Cost of Equity:

Cost of equity under the dividend discount model

Cost of Enquity re = (Dividend in next period/Current Market price)+Growth%

Cost or Equity re = (4/30)%+ 5% = 18.33%

Calculation of WACC

WACC = wdrd (1 - t) + wprp + were

where

wd        is the proportion of debt that the company uses when it raises new funds

rd         is the before-tax marginal cost of debt

t           is the company

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