Zinn Corp. has 3.50 million shares of common stock outstanding. The firm is in s
ID: 2803032 • Letter: Z
Question
Zinn Corp. has 3.50 million shares of common stock outstanding. The firm is in steady-state growth, and analysts expect the firm’s earnings and dividends to continue to grow at their historical rate for the foreseeable future—per share dividends on common have grown from $2.00 six years ago to $2.70 today. Each share of Zinn’s common stock is selling for $34.07 today. The firm’s beta is estimated to be 1.80. The long-term Treasury rate is 2.75%, and the expected market risk premium is 5.75%. Analysts estimate that potential equity investors will require a premium of 5% over the firm’s bond yield.
The firm’s long-term debt consists of 7.25% coupon bonds, which were issued 9 years ago with an original maturity of 25 years. These bonds pay interest semiannually. Today, these bonds have a yield of 8.75%. The book value of these bonds is $300 million. Zinn Corp. also has 495,000 shares of perpetual preferred stock outstanding, and these pay a fixed dividend of $8 per year on a face value of $50. Each share of the firm’s preferred currently sells for $79. The firm’s marginal tax rate is 40%. Estimate the firm’s weighted average cost of capital (WACC).
Explanation / Answer
Cost of equity
CAPM = 2.75% + 1.8*5.75%
= 13.1%
Dividend dscount model
Compunded annual growth rate = ( EV / BV)1 / n - 1
= (2.7 / 2 )1/6 - 1
= 5.13%
Price of stock = D1 / (k-g)
34.07 = (2.7*1.0513) / (k-0.0513)
k = 13.46%
Average cost of equity = (13.46%+13.1%)/2
= 13.3%
After tax Cost of debt = 8.75%*(1-0.4)
= 5.25%
Cost of preferred stock = dividend / price
= 8 / 79
= 10.13%
Value of equity = 3500000*34.07
= $11,92,45,000
Value of debt = 872.12*3000000
= $2,61,63,66,516
Value of pref stock = 495000*79
= $3,91,05,000
WACC calculation is shown below:
Capital Cost Market value Weights Wieghted cost Equity 13.30% 11,92,45,000 0.043 0.006 Debt 5.25% 2,61,63,66,516 0.943 0.050 Pref 10.13% 3,91,05,000 0.014 0.001 2,77,47,16,516 5.66%Related Questions
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