Weighted Average cost of capital (WACC)

1. Given the following information below, calculate the WACC of the project.

Firm ‘A’ capital structure consists of debt, common stock and preferred
stock.

• The tax rate is 35% (Tax)

• Return on the equity market index is 11% (Rm)
• The (Debt/ Total Assets) ratio is 2/3
• The maturity of the bond contract is 30 years (N)
• The price of the preferred stock is $62 (Pps)
• The systematic risk is 0.7 (b)
• The return on T-bill is 1.5% (Rrf)
• The coupon rate is 8% paid quarterly (PMT)
• The preferred dividend is $8.75 (Div)
• The current bond price is $0.986 millions (Pv)
• The common stocks represent 68% of the total equity.
• Face value of the bonds it issued is $1 million (Fv)
1) Cost of Common Stock (Kcs):
Rs = Rrf + b (Rm - Rrf)
= 0.015 + (0.7)(0.11 – 0.015)
= 0.0815 = 8.15 %

2) Weight of Common Stock (Wcs):

Wcs = 1 – (2/3) = 0.3333
Wcs = (68/100) x 0.3333 = 0.226 = 22.66 %

3) Cost of Preferred Stock (Kps):

Kps = Div / Pps
= 8.75 / 62
= 0.1411 = 14.11 %
4) Weight of Preferred Stock (Wps): 100 – (22.66 + 66.67) = 10.67 %

5) Cost of Debt (Kd):

N = 30 x 4 = 120
Pv = - 986,000
Fv = 1,000,000
PMT = (8 / 100) x 1,000,000 = 80,000 / 4 = 20,000
I=?

I = 2.0312 x 4 = 8.1249 %

6) Weight of Debt (Wd) = 2/3 = 0.6667 = 66.67 %

7) WACC = [Wd x (Kd)(1 – Tax)] + [Wps x Kps] + [Wcs x Kcs]

= [(0.6667) x (0.081249)(1 – 0.35)] + [(0.1067) x (0.1411)] + [(0.2266) x (0.0815)]
= 0.0687
= 6.87 %
2. Given the following information below, calculate the WACC of the project.

Firm ‘B’ capital structure consists of debt, common stock and preferred
stock.

• The current common stock price is $114 (Pcs)

• The (total equity/ total assets) ratio = 0.4
• The maturity of the bond contract is 180 quarters (N)
• The price of the preferred stock is $102 (Pps)
• The forecasted ROE is 10.46, and the company decides to pay 35% of its
earnings to the shareholders. (ROE & Plowback Ratio)
• The tax rate is 30% (Tax)
• The coupon rate is 12% paid monthly (PMT)
• The preferred dividend is 1.35% and par value of the stock is $1000 (Div)
• The current bonds price is $101,065 thousands (Pv)
• The preferred equity represents 28% of total equity
• The next common dividend is $2.5 (Next Div)
• The face value of the bonds issued is $100 thousands (Fv)
1) Cost of Common Stock (Kcs):
g = ROE x (1 – plowback ratio)
= 10.46 x (1 – 0.35)
= 6.799 %

r = (Div / P) + g
= (2.5 / 114) + 0.06799
= 0.0899 = 8.99 %

2) Weight of Common Stock (Wcs):

Wcs = 100 – (11.2 + 60) = 28.8 %

3) Cost of Preferred Stock (Kps):

Div = (1.35 / 100) x 1000 = 10.35

Kps = Div / P
= 10.35 / 102
= 0.1015 = 10.15 %

4) Weight of Preferred Stock (Wps): 0.28 x 0.4 = 0.1120 = 11.20 %

5) Cost of Debt (Kd):

N = 180 x 3 = 540
Pv = - 101,065
Fv = 100,000
PMT = (12 / 100) x 100,000 = 12,000 / 12 = 1,000
I=?

I = 0.9894 x 12 = 11.8729 %

6) Weight of Debt (Wd) = 1 – 0.4 = 0.6 = 60 %

7) WACC = [Wd x (Kd)(1 – Tax)] + [Wps x Kps] + [Wcs x Kcs]

= [(0.6) x (0.1187)(1 – 0.30)] + [(0.1120) x (0.1015)] + [(0.288) x (0.0899)]
= 0.0872
= 8.72 %