Finding the WACC Given the following information for Fairview Co., find the WACC

ID: 2757392 • Letter: F

Question

Finding the WACC Given the following information for Fairview Co., find the WACC. Assume the company’s tax rate is 35 percent.

Debt: 7,000 8 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 104 percent of par; the bonds make semiannual payments.

Common stock: 120,000 shares outstanding, selling for $82 per share; the beta is 1.20.

Preferred Stock: 10,000 shares of 5.25 percent preferred stock outstanding, currently selling for $80 per share.

Market: 7 percent market risk premium and 4.5 percent risk-free rate.

Explanation / Answer

Debt

FV = 1000

N = 20 x2 =40

PV = 1000 x 104% = $1040

Pmt = 1000 x 8%/ 2 = $40

Before tax cost of debt = 3.8038% x 2 =7.61%

After tax cost of debt Kd = 7.61% x (1-0.35) = 4.94%

Amount of debt = 7000 x $1040 = $7,280,000

Common stock

Ke = Rf +MRP x Beta

=4.50% + 7% x 1.20

= 12.90%

Amount of common stock =120,000 x82

= $ 9,840,000

Preferred Stock

Kp = preferred dividend/ price

= $100 x 5.25% / $80

= 6.56%

Amount of preferred stock = $80 x 10,000 = $800,000

Calculation of WACC:

Source

Amount

Cost

Amount x cost

Debt

7280000

4.94%

359632

Common stock

9840000

12.90%

1269360

Preferred Stock

800000

6.56%

52480

17920000

1681472

WACC = sum of amount x cost / total amount

= 1681472 / 17920000

= 9.38%