Calculate the WACC for PG given the following: a) The company has outstanding de

Question

Calculate the WACC for PG given the following: a) The company has outstanding debt that matures in 20 years that has a coupon of 9%. It pays interest semi-annually and the bonds are callable in 3 years at a 3% premium to par. The current price of the bonds is 1214.59. For a reference 20 year Treasuries are yielding 3.5%. (PG bonds are rated AA) b) PG has outstanding preferred that have an 8% coupon, $100 par value and is currently priced at $120. If new preferred was issued the company would incur flotation costs of 5%. c) The company’s stock is currently priced at $100 and the current dividend is $3.00. That dividend is expected to grow at 3% forever. The beta of PG is 0.6 and the RFR and MRP are 3% and 7% respectively. Ignore flotation costs for your cost of equity. d) The target structure is 60% equity, 30% debt and 10% preferred. The tax rate is 40%. e) If the company had no residual cash and new issued equity would incur a flotation cost of 10%. Calculate a new the WACC using only the DCF method for equity and keeping all other factors the same. Comment on your findings

Explanation / Answer

Step 1:

1) DCF method for equity, Ignore flotation costs for your cost of equity menioned in problem

Cost of Equity = Expected Dividend/Current Price + growth rate

Cost of Equity = 3*1.03/100 + 3%

Cost of Equity = 6.09%

2) Cost of Preferred Stock = 8/(120-5%*120)

Cost of Preferred Stock = 7.0175%

3) Before Tax Cost of Debt = 20 year Treasuries are yielding

Before Tax Cost of Debt = 3.5%

After Tax Cost of Debt = Before Tax Cost of Debt *(1-tax rate)

After Tax Cost of Debt = 3.5%*(1-40%)

After Tax Cost of Debt = 2.1-%

Step 2:

Weight of Equity = 60%

Weight of Preferred Stock = 10%

Weight of Debt = 30%

Step3:

WACC = Weight of Equity* Cost of Equity + Weight of Preferred Stock* Cost of Preferred Stock + Weight of Debt* After Tax cost of Debt

WACC = 60%*6.09 + 10%*7.0175 + 30%*2.1

WACC = 4.99%

Note : WACC is calculated using cost of Equity ignoring flotation costs as mentioned in problem , if it would have been considered WACC has been increased.

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