LUVFINANCE, Inc. is estimating its WACC. It is operating at its optimal capital structure. Its outstanding bonds have a 12 percent coupon, paid semiannually, a current maturity of 17 years, and sell for $1,162. It has 100,000 bonds outstanding. The firm can issue new 20-year maturity semiannual bonds at par but will incur flotation costs of $50 per bond. The firm could sell, at par, $100 preferred stock that pays a 12 percent annual dividend that is currently selling for $120. The firm currently has 1,000,000 shares of preferred stock outstanding. Rollins' beta is 0.94, the risk-free rate is 3.72 percent, and the market risk premium is 6 percent. The common stock currently sells for $100 a share and there are 5,000,000 shares outstanding. The firm's marginal tax rate is 40 percent.

Required:
What is the WACC?

Question

contestada

Respuesta :

AbsorbingMan AbsorbingMan · Answer 1 · 2021-03-25T12:30:15+01:00

Solution :

Given :

The cost of the debt is yield to the maturity of the bonds.

The yield on the bond is 10%

The tax rate is 40%

After the tax cost of the debt = 10 ( 1- 0.4 )

= 6 %

Add floatation cost at the rate of 5% = 11%

Cost of the preferred stock = [tex]$\frac{\text{dividend}}{\text{price}}$[/tex]

= [tex]$\frac{120}{12}$[/tex] = 10%

The cost of equity = risk free rate + β x market risk premium

= 3.72 + 0.94 x 6

= 9.36%

WACC is weighted average of the individual securities :

Particulars Value per No. of Market value Weight Cost of Product

security securities security

Bonds 1162 100,000 116,200,000 0.1578 11 1.73621298

Preferred 120 1,000,000 120,000,000 0.1629 10 1.6299918

stocks

Equity 100 5,000,000 500,000,000 0.6791 9.36 6.356968

736,200,000 1 WACC 9.7231730

Therefore, WACC of the firm is 9.72%