Calculate the WACC for Martin Industries given: A tax rate of 34%, the market re

Question

Calculate the WACC for Martin Industries given:

A tax rate of 34%, the market return is 13.2% and the risk-free rate is 4.5%.

7,500 preferred stock shares selling at $88/share with a 6% dividend rate.

265,000 common shares outstanding selling for $76/share. The stock has a beta of 0.92 and will pay a dividend of $2.48 next year. The dividend is expected to grow by 4% per year indefinitely.

8,500 coupon bonds outstanding with a 7.1% coupon rate and 14 years to maturity. The quoted price is 102.6. Interest is paid semiannually.

Explanation / Answer

Bond details Bond Par Value(assuming as per market price given)                         100 Bond Market Price                   102.60 Years To maturity                     14.00 Annual Interest @7.1%= $                   7.10 YTM Formula= [Annual Interest+(Par Value-Market Value)/Years to Maturity]/(Par value+Market Price*2)/3 YTM= [7.1+(100-102.6)/14]/(100+102.6*2)/3 YTM =6.8% Tax Rate =34% Post Tax cost of debt =6.8%*(1-34%)= 4.49% So Post Tax ost of Debt = 4.49% No of bomds =               8,500.00 Matket Value of Bonds=          872,100.00 Preference share Price of Preference share=                     88.00 Assume par value =100 Dividend @6% =                       6.00 Cost of Preference share=6/88= 6.82% No of preference shares=               7,500.00 Market Value of preference shares=          660,000.00 Common Equity No Of shares outstanding          265,000.00 Selling Price                       76.00 Market Value common stock=          20,140,000 Risk Free rate=Rf= 4.50% Market Return =Rm= 13.20% Stock beta=                       0.92 Required stock return =rs rs=Rf+(Rm-Rf)*Beta =4.5% +(13.2%-4.5%)*0.92              = 12.50% So Cost of Common stock=12.5% By Gordon's Model Dividend growth rate=g=4% Next dividend =D1=2.48 Assume cost of equity =k So P0=76=D1/(k-g) 76=2.48/(k-0.04) 76k-3.04=2.48 76k=5.52 k=7.26% So cost of Equity as per Gordon's model = 7.26% Taking the CAPM cost of equity for WACC WACC   Type of capital Market Value % Value Post Tax cost Wtd cost Debt                872,100 4.02% 4.49% 0.18% Preferred Stock                660,000 3.05% 6.82% 0.21% Common Stock          20,140,000 92.93% 12.50% 11.62% Total          21,672,100 12.01% So WACC is 12.01% assuming CAPM cost for Common stock

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