Question

Calculate the WACC which represents the “hurdle rate” for a typical project with average risk using the average of the range of the marginal cost of common equity using retained earnings or new earnings.

                                                          

Data:

A 15-year, 12% coupon, semiannual payment non-callable bonds sell for $1,153.72. New bonds will be privately placed with no flotation cost.

A 10%, $1,000 par value, annually dividend, perpetual preferred stock sells for $1,111.

Both an existing common stock and a new common stock issue, which incurs a flotation cost of 15% of the proceeds, sells for $50. D₁ = $4.3995 and g = 5%. b = 1.2; r_RF = 7%; RP_M = 6%.

Bond-Yield Risk Premium = 4%.

Target capital structure: 20% debt, 20% preferred, 60% common equity.

The tax rate is 35%.

Answer 1

D2 : X V fix =C2/$C$11 A co Market value Weights $ 60 0.6000 Component Cost WACC (Cost %*Weights) 8.40% 2 Common stock 14.00% $ 20 0.2000 1.80% 5 Preferred stock 6 9.00% =100/1111 7 $ 20 0.2000 8 Debt 9 1.30% 6.50% =RATE(15*2,120/2.-1153.72.1000)*2*(1-35%) 1.30% Total $ 100 1.0000 12 Weighted average cost of capital 11.50% 14 15 Common stock (under dividend growth) 13.80%=4.3995/50+5% 16 Common stock (under CAPM) 14.20% =7%+1.2*6% 17 18 Average common stock cost 14.00%

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