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The Saunders Investment Bank has the following financing outstanding.

Debt: 60,000 bonds with a coupon rate of 5.1 percent and a current price quote of 106.1; the bonds have 15 years to maturity and a par value of $1,000. 18,900 zero coupon bonds with a price quote of 21.6, 27 years until maturity, and a par value of $10,000. Both bonds have semiannual compounding.

Preferred stock: 155,000 shares of 2.9 percent preferred stock with a current price of $84 and a par value of $100.
Common stock: 2,300,000 shares of common stock; the current price is $92 and the beta of the stock is 1.20.
Market: The corporate tax rate is 25 percent, the market risk premium is 6.9 percent, and the risk-free rate is 3.5 percent.

Required:
What is the WACC for the company?

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Answer:

11,73 %

Explanation:

WACC = Ke × (E/V) + Kd × (D/V) + Kp × (E/V)

Ke = Cost of Equity

     = Return on Risk Free Security + Beta × Risk Premium

     = 3.5 % + 1.20 × 6.9 %

     = 11.78 %

E/V = Weight of Equity

      = (2,300,000 × $92) ÷ (2,300,000 × $92 + 60,000 × $106.10 + 18,900 × $21.60 + 155,000 × $84)

      = 0.91

Kd = Cost of Debt

Debt : 60,000 bonds

Pv = ($106.10)

Pmt = (5.10% × $1,000) ÷ 2 = $25.50

n = 15 × 2 = 30

Fv = $1,000

P/yr = 2

i = ?

Pre-tax cost = 48.66 %

After tax cost = 0.75 × 48.66 %

                      = 36.50%

DV = Weight of Debt

     = (60,000 × $106.10) ÷ (2,300,000 × $92 + 60,000 × $106.10 + 18,900 × $21.60 + 155,000 × $84)

     = 0.03

Debt : 18,900 zero coupon bonds

Pv = ($21.60)

Pmt = $0

n = 27 × 2 = 54

Fv = $10,000

P/yr = 2

i = ?

Pre-tax cost = 24,07 %

After tax cost = 0.75 × 24,07 %

                       = 18.05%

DV = Weight of Debt

     = (18,900 × $21.60) ÷ (2,300,000 × $92 + 60,000 × $106.10 + 18,900 × $21.60 + 155,000 × $84)

     = 0.002

Kp = Cost of Preference Share

Market Rate = (Return × Par Value) ÷ Current Price

                     = (2.90 % ×  $100) ÷ $84

                     = 0.03 %

P/V = Weight of Preference Shares

      = (155,000 × $84) ÷ (2,300,000 × $92 + 60,000 × $106.10 + 18,900 × $21.60 + 155,000 × $84)

      = 0.06

WACC = 11.78 % × 0.91 + 36.50% × 0.03 + 18.05% × 0.002 + 0.03 % ×  0.06

           = 11,73 %

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