8. Rol firm\'s beta is 1.3 and the market risk premium is 6.5% are 9,000 shares

Question

8. Rol firm's beta is 1.3 and the market risk premium is 6.5% are 9,000 shares of preferred stock outstanding at a price of $22a 1 Tide, Inc. has 10,000 shares of common stock outstanding at a price of S18 a share. The The Treasury bill rate is 3.5%. There share; each quarterly dividend pay . Roll Tide's has 400 bonds 15 year bonds which have 6 years left to maturity. They pay a coupon rate of 7% and are trading at 105% of par. The tax rate is 34 percent. What is the weighted average cost of capital for the firm? (10 points) ment on preferred stock is $0.45

Explanation / Answer

Debt:

Number of bonds outstanding = 400
Face Value = $1,000
Current Price = 105%*$1,000 = $1,050

Value of Debt = 400 * $1,050
Value of Debt = $420,000

Annual Coupon Rate = 7%
Semiannual Coupon Rate = 3.50%
Semiannual Coupon = 3.50%*$1,000 = $35

Time to Maturity = 6 years
Semiannual Period to Maturity = 12

Let semiannual YTM be i%

$1,050 = $35 * PVIFA(i%, 12) + $1,000 * PVIF(i%, 12)

Using financial calculator:
N = 12
PV = -1050
PMT = 35
FV = 1000

I = 3.00%

Semiannual YTM = 3.00%
Annual YTM = 2 * 3.00%
Annual YTM = 6.00%

Before-tax Cost of Debt = 6.00%
After-tax Cost of Debt = 6.00% * (1 - 0.34)
After-tax Cost of Debt = 3.96%

Preferred Stock:

Number of shares outstanding = 9,000
Current Price = $22
Quarterly Dividend = $0.45

Value of Preferred Stock = 9,000 * $22
Value of Preferred Stock = $198,000

Cost of Preferred Stock = 4 * Quarterly Dividend / Current Price
Cost of Preferred Stock = 4 * $0.45 / $22
Cost of Preferred Stock = 8.18%

Equity:

Number of shares outstanding = 10,000
Current Price = $18

Value of Common Stock = 10,000 * $18
Value of Common Stock = $180,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 3.5% + 1.30 * 6.5%
Cost of Common Equity = 11.95%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $420,000 + $198,000 + $180,000
Value of Firm = $798,000

Weight of Debt = $420,000/$798,000
Weight of Debt = 0.5263

Weight of Preferred Stock = $198,000/$798,000
Weight of Preferred Stock = 0.2481

Weight of Common Stock = $180,000/$798,000
Weight of Common Stock = 0.2256

WACC = Weight of Debt*After-tax Cost of Debt + Weight of Preferred Stock*Cost of Preferred Stock + Weight of Common Stock*Cost of Common Stock
WACC = 0.5263*3.96% + 0.2481*8.18% + 0.2256*11.95%
WACC = 6.81%

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