You have been asked to calculate the WACC of a company that you firm is trying t

Question

You have been asked to calculate the WACC of a company that you firm is trying to value. The firm has the following element of capital:

1. Short Term Debt

Market Value = $30 million; Return = 4.50%

2. Long Term Debt

Par (Face Value) = $450 million; Coupon rate = 6.00%; Maturity 10 years: Current yield to maturity is 6.20%

3. Common Equity

a. Class A shares (publically Traded)

30 million share outstanding; beta = 1.20; Latest Price = $22.40

b. Class B Shares (Not publically Traded)

10 million Share Outstanding; Estimated Beta = 1.40; Last Dividend Paid: $2.00 per share; Expected growth rate in dividends = 5%

4. Preferred Stock

2 million shares outstanding; Market Price = 100; Dividend Share = $5.00

Note: Do not use Floatation Cost i.e. Flotation cost = 0; Risk free rate = 2.00% and expected return on the market is 6.00%.

The firm’s tax rate is 40%

Explanation / Answer

Answer Calculation of Weight of stock & debt in Capital Sl. no. Particulars Qty Current Market Rate Current Market value Weight 1 Short Term Debt 30000000              30,000,000 0.89% 2 Long Term Debt       450,000,000             450,000,000 13.42% 3 Class 'A' Shares         30,000,000 22.40             672,000,000 20.05% 4 Class 'B' Shares         10,000,000 200          2,000,000,000 59.67% 5 Preferred Stock          2,000,000 100             200,000,000 5.97% Total Market Value of stock & Debt          3,352,000,000 100.00% Calculation of WACC Sl No. Particulars Weight Cost Weight * Cost 1 Short Term Debt 0.89% 2.70% 0.02% 2 Long Term Debt 13.42% 3.72% 0.50% 3 Class 'A' Shares 20.05% 6.80% 1.36% 4 Class 'B' Shares 59.67% 7.60% 4.53% 5 Preferred Stock 5.97% 5.00% 0.30% Total 100.00% 6.72% WACC = 6.72% Worrking Notes 1 Shares Value of Class B = 2/0.06-0.05 = 200 2 Short Term Debt Cost =rd(1-tax rate) = 4.50(1-0.40) = 2.70% 3 Long Term Debt Cost =rd(1-tax rate) =6.20(1-0.40) = 3.72% 4 Class 'A' Shares Cost of Equity = Risk Free rate+beta *Market risk premium = 2+1.20*(6-2) =6.80% 5 Class 'B' Shares Cost of Equity = Risk Free rate+beta *Market risk premium = 2+1.40*(6-2) =7.60% 6 Preferred Stock = 5%

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