Question

LFinance, 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 (Hint: the coupon rate on the new bonds = the YTM on existing bonds). 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 0.85, the risk-free rate is 2.53 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. What is the WACC?

Answer 1

Assuming he common stock currently sells for $100 a share if the firm's marginal tax rate is 40 percent. The WACC is: 7.54%.

Weighted average cost of capital

First step

PV= 1162+50= (1212)

FV= 1000

PMT= (100×10)/2= 50

N= 20×2= 40

CPT I/Y= 3.94×2= 7.88%

Second step

Market value

1212×100,000=121,200,000

120×1,00,000=120,000,000

100×5,000,000=500,000,000

Total Market value $741,200,000

Percentage

121,200,000/741,200,000=0.1635

120,000,000/741,200,000=0.1619

500,000,000/741,200,000=0.6746

Third step

12/120= 10%

2.53%+(0.85×0.06)

0.0253+0.051

=0.0763×100

=7.63%

Hence:

WACC=0.0788×[.1635(1-.4)]+(0.1619×.10)+(0.6746×0.0763)

WACC=(0.0788×0.0981)+(0.1619×.10)+(0.6746×0.0763)

WACC=0.00773028+0.01619+0.05147198

WACC=0.07539×100

WACC=7.54% (Approximately)

Inconclusion the WACC is: 7.54%.

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