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Corporate Finance – Sample 1

Question:

Calculate the WACC for Zee Corp. Zee’s total capital is $2.0 million of which $970,000 is debt and $170,000 is preferred stock.Zee’s preferred annual dividend is $1.55, and its preferred stock is currently trading at $22.00/share. Zee just paid common dividend of $1.60/share and is growing at a constant rate of 7% annually. Zee’s stock is priced at $23/share and its beta is .91. .Zee’s has primarily long-term debt, currently trading at 925.55/bond. The 7.5% coupon, 30 year bonds have 15 years left to maturity. Zee is in the 32 percent tax bracket.
Answer:

Cost of preferred Stock = Dividend/Price = 1.55/22  = 7.05%

Cost of debt :

Price = 925.55                     Coupon = 75 annual payment                      Time left to maturity = 15 years

Maturity Amount

Using excel PV function:

PV = -925.55, NPER = 15,   FV = 1000   &  PMT = 75

Before tax cost of debt = 8.39%

After tax cost of debt = 8.39 *(1-.32) = 5.71%

Cost of equity:

Ke = D1/P0 + g = 1.6(1+.07)/23 + .07 = 14.44%

 

WACC:

Market Value Weight Cost Weighted Cost
Equity 860000 0.43 14.44% 6.21%
Debt 970000 0.485 5.71% 2.77%
Preferred Stock 170000 0.085 7.05% 0.60%
Total 2000000 9.58%

 

WACC = 9.58%

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