Computer CALCULATING THE WACC Here is the condensed 2016 balance sheet for Skye

Question

Computer CALCULATING THE WACC Here is the condensed 2016 balance sheet for Skye Company (in thousands of dollars): 0-21 2016 Current assets Net fixed assets Total assets $2,000 3,000 $%5,000 Accounts payable and accruals Short-term debt Long-term debt Preferred stock (10,000 shares) Common stock (50,000 shares) Retained earnings Total common equity Total liabilities and equity $ 900 100 1,100 250 1,300 1,350 $2.650 $5,000 Skye's earnings per share last year were $3.20. The common stock sells for $55.00, las year's dividend (Do) was $2.10, and a flotation cost of 10% would be required new common stock. Security analysts are projecting that the common dividend wi grow at an annual rate of 9%. Skye's preferred stock pays a dividend of $3.30 per share, and its preferred stock sells for $30.00 per share. The firm's before-tax cost to sell of

Explanation / Answer

a) After-tax cost of debt = Before-tax cost of debt x (1 - tax rate) = 10% x (1 - 35%) = 6.50%

Cost of preferred stock = Dividend / Price = 3.3 / 30 = 11%

Cost of retained earnings = D0 x (1 + g) / P + g = 2.1 x (1 + 9%) / 55 + 9% = 13.16%

Cost of new equity = D0 x (1 + g) / P x (1 - f) + g = 2.1 x (1 + 9%) / 55 x (1 - 10%) + 9% = 13.62%

b) Using CAPM, cost of retained earnings = Rf + beta x MRP = 6% + 1.516 x 5% = 13.58%

c) Cost of new equity = 13.58% + (13.62% - 13.16%) = 14.04%

d) Market Value of debt = $1,100,000, Market value of preferred stock = 10,000 x 30 = $300,000, Market Value of equity = 50,000 x 55 = $2,750,000 => Total Value = 4,150,000

Weight of debt, wd = 1,100 / 4,150 = 26.5%, wps = 7.2%, we = 66.3%

WACC = 26.5% x 6.5% + 7.2% x 11% + 66.3% x 13.2% = 11.24% (using retained earnings)

WACC = 26.5% x 6.5% + 7.2% x 11% + 66.3% x 13.6% = 11.54% (using new equity)

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