Question

Debt 5,000 bonds par $1,000 with a maturity 20 years; semi annual compounding. Coupon rate 8%. Price $1,310. Tax rate=33% Preferred 50,000 shares of 3% par value $100 stock. Current price $63.00. Common stock 72,000 shares currently selling for $87.00. The beta of the firm is 1.17, the risk free rate is 2.78%, Market return (Rm) =8.6%. What is the cost of Debt; Cost of Preferred Stock; Cost of Equity and what is the WACC?

Answer 1

a.	Cost of debt		3.64%
Working:
# 1	Before tax cost of debt	=	=rate(nper,pmt,pv,fv)*2
		=	5.44%
	Where,
	nper		40
	pmt		$               40
	pv		$       -1,310
	fv		$         1,000
# 2	After tax cost of debt	=	Before tax cost of debt*(1-Tax rate)
		=	5.44%	*(1-0.33)
		=	3.64%
b.	Cost of preferred stock	=	Preferred dividend	/	Current Price
		=	$           3.00	/	$    63.00
		=	4.76%
c.	As per Capital Asset Pricing Model,
	Cost of Equity	=	Risk free rate	+	Beta	*	(Market return - Risk Free rate)
		=	2.78%	+	1.17	*	(8.6%-2.78%)
		=	9.59%
d.	WACC	6.20%
Working;
# 1	Market price of :
	Debt	5,000	*	$             1,310	=	$       65,50,000
	Preferred stock	50,000	*	$                   63	=	$       31,50,000
	Equity	72,000	*	$                   87	=	$       62,64,000
	Total					$    1,59,64,000
	So, weight of :
	Debt	$ 65,50,000	/	$ 1,59,64,000	=	0.4103
	Preferred stock	$ 31,50,000	/	$ 1,59,64,000	=	0.1973
	Equity	$ 62,64,000	/	$ 1,59,64,000	=	0.3924
# 2			Weight	Cost
			a	b	a*b
	Debt		0.4103	3.64%	1.49%
	Preferred stock		0.1973	4.76%	0.94%
	Equity		0.3924	9.59%	3.76%
	WACC				6.20%