The Saunders Investment Bank has the following financing outstanding. 30,000 bon

Question

The Saunders Investment Bank has the following financing outstanding.

  

30,000 bonds with a coupon rate of 6 percent and a current price quote of 112.0; the bonds have 20 years to maturity. 200,000 zero coupon bonds with a price quote of 21.0 and 30 years until maturity.

120,000 shares of 4 percent preferred stock with a current price of $86, and a par value of $100.

2,300,000 shares of common stock; the current price is $72, and the beta of the stock is 1.50.

The corporate tax rate is 25 percent, the market risk premium is 8 percent, and the risk-free rate is 5 percent.

  
What is the WACC for the company?

  Debt:

30,000 bonds with a coupon rate of 6 percent and a current price quote of 112.0; the bonds have 20 years to maturity. 200,000 zero coupon bonds with a price quote of 21.0 and 30 years until maturity.

  Preferred stock:

120,000 shares of 4 percent preferred stock with a current price of $86, and a par value of $100.

  Common stock:

2,300,000 shares of common stock; the current price is $72, and the beta of the stock is 1.50.

  Market:

The corporate tax rate is 25 percent, the market risk premium is 8 percent, and the risk-free rate is 5 percent.

Explanation / Answer

Cost of debt

Coupon bond

Let cost of debt be r1

Coupon payment = 6%*1000= 60

112%*1000 = 60/(1+r1) + 60/(1+r1)^2 + 60/(1+r1)^3......60/(1+r1)^20 + 1000/(1+r1)^20

r1 = 5.03%

market value of bonds = 30000*112%*1000= 33600000

Zero coupon bond

Let cost of debt be r2

21%*1000 =1000/(1+r2)^30

r2= 5.34%

market value of bonds = 200000*21%*1000=$42000000

Weighted average cost of debt = (42000000*5.34% + 33600000*5.03%)/(33600000+42000000) = 5.20%

Total value of debt = 33600000+42000000=75600000

Cost of equity calculation

re = 5% + 1.5*8% = 17%

market value of equity = 2,300,000*72=165,600,000

Cost of preferred stock calculation

120,000 shares of 4 percent preferred stock with a current price of $86, and a par value of $100.

86 = 4%*100/rp

rp= 4.65%

market value of preferred stock = 120,000*86=10320000

WACC for the company = (re*E + rd*D*(1-tax) + rp*P)/(E+D+P)

= (17%*165,600,000+ 5.20%*75600000*(1-25%) + 4.65%*10320000)/(10320000+165,600,000+75600000)= 12.56%

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