Question

Consider Higgins Production which has the following information about its capital structures: Debt - 4,500, 5% coupon bonds outstanding, $1,000 par value, 7 years to maturity, selling for 80 % of par, the bonds make semiannual payments • Common Stock - 100,000 shares outstanding, selling for $35 per share; the beta is 1.20 • Preferred Stock - 19,000 shares of 6 % preferred stock outstanding, currently selling for $150 per share • Market Information - 6 %t market risk premium and 4 % risk-free rate. Required: Calculate to the following if the company has a tax rate of 36 percent. i. Total Market Value for the Firm ii. After-tax cost of Debt iii. Cost of Equity iv. Cost of Preferred Stock v. Weighted Average Cost of Capital

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=35*100000

=3500000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*4500*0.8

=3600000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=150*19000

=2850000

i) MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=3500000+3600000+2850000

=9950000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 3500000/9950000

W(E)=0.3518

Weight of debt = MV of Bond/MV of firm

Weight of debt = 3600000/9950000

W(D)=0.3618

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 2850000/9950000

W(PE)=0.2864

III Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 4 + 1.2 * (6)

Cost of equity% = 11.2

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =7x2

800 =∑ [(5*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^7x2

k=1

YTM = 8.900128943

ii. After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 8.900128943*(1-0.36)

= 5.70

Iv. cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 6/(150)*100

=4

v. WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=5.7*0.3618+11.2*0.3518+4*0.2864

WACC =7.15%