Homework Answers
WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of common stock * cost of common stock)
market value of debt = bonds outstanding * market price per bond
market value of common stock = shares outstanding * market price per share
weight of debt = market value of debt / total market value
weight of common stock = market value of common stock / total market value
cost of debt = YTM of bond * (1 - tax rate)
YTM is calculated using RATE function in Excel with these inputs :
nper = 9*2 (9 years to maturity with 2 semiannual coupon payments each year)
pmt = 1000 * 4.5% / 2 (semiannual coupon payment = face value * annual coupon rate / 2. This is a positive figure as it is an inflow to the bondholder)
pv = -1015 (current bond price. This is a negative figure as it is an outflow to the buyer of the bond)
fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)
The RATE calculated is the semiannual YTM. To calculate the annual YTM, we multiply by 2. Annual YTM is 4.30%. This is the pretax cost of debt.
cost of debt = YTM * (1 - tax rate)
cost of debt = 4.30% * (1 - 25%) ==> 3.22%
cost of equity = risk free rate + (beta * market risk premium)
cost of equity = 1.50% + (2.3 * 8%) ==> 19.90%
WACC = 16.01%
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