Question

Consider the case of Kuhn Co. Kuhn Co. is considering a new project that will require an initial investment of $4 million. It has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. Kuhn has noncallable bonds outstanding that mature in 15 years with a face value of $1,000, an annual coupon rate of 11%, and a market price of $1,555.38. The yield on the company's current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividend of $9 at a price of $92.25 per share. You can assume that Jordan does not incur any flotation costs when issuing debt and preferred stock. Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay a dividend of $1.36 at the end of next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 40%. Determine what Kuhn Company's WACC will be for this project.

Answer 1

Cost of debt = Kd =

(Facevalue-Current Price) Interest(1 - Taxrate) + Yearsto Maturity (Facevalue + Current Price)/2

For Old Bond interest Rate is 11% and Year to Maturity is 15 years. Further Current Price is 1555.38 and Par value is 1000$

so, Kd=

1101_n 110(1 -0.40) + 1 ny (100-1555.38) (1000 + 1555.38) 2

By sholwing this we get = (66-37.03)/1277.69 = 2.27%,

so Cost of Debt - Kd = 2.27%

Kp= Cost of Preference Share = Dividend Obligation/Net Proceed

Kp = 9/92.50*100 = 9.76%

and Ke = Cost of Equity

Ke = (D1/P0) + G

Where, D1 = Expected Dividend in next yea in this case 1.36

P0 = Current Share Price as reduced by flotation cost = (33.35) - (33.35*8/100) = 30.682

G= Growth rate = 9.2%

So, Ke will be = (1.36/30.682) + 9.2%

Ke = 13.63%

Particular	Formula	Cost
Cost of Debt	((((1000*11/100)*(1-0.4))+((1000-1555.38)/15)))/((1000+1555.38)/2)*100	2.27%
Cost of Preference Share	(9/92.25)*100	9.76%
Cost of Common Stock	(1.36)/(33.35-(33.35*8/100)+0.092	13.63%

Now WACC Will Be Computed as follow.

WACC is counted considering Cost of particular source of Finance with respect to total Weight of that source in total Finance

Source of Capital	Weight (given)	Cost of Capital	WACC %(Weight * Cost of Capital)
Bond	0.580	2.27%	1.32%
Preference Share	0.060	9.76%	0.59%
Common Stock	0.360	13.63%	4.91%
Total	1.000		6.81%