Preferred stock in wacc calculation

WACC Calculation Problems

PROBLEMS

WACC Calculation

1. Blazingame Inc.'s capital components have the following market values:

Debt $35,180,000

Preferred Stock $17,500,000

Common Equity $48,350,000

Calculate the firm's capital structure and show the weights that would be used for a weighted average cost of capital (WACC) computation.

2. The Aztec Corporation has the following capital components and costs. Calculate Aztec's WACC.

Component Value Cost

Debt $23,625 12.0%

Preferred Stock $ 4,350 13.5%

Common Equity $52,275 19.2%

3. Willerton Industries Inc. has the following balances in its capital accounts as of 12/31/x3:

Long Term Debt $65,000,000

Preferred Stock $15,000,000

Common Stock $40,000,000

Paid in Excess $15,000,000

Retained Earnings $37,500,000

Calculate Willerton’s capital structure based on book values.

5. Again referring to Willerton of the two previous problems, assume the firm’s cost of retained earnings is 11% and its marginal tax rate is 40%, calculate its WACC using its book value based capital structure ignoring floatation costs. Make the same calculation using the market value based capital structure. How significant is the difference?

6. A relatively young firm has capital components valued at book and market and market component costs as follows. No new securities have been issued since the firm was originally capitalized.

Values Market

Component Market Book Cost

Debt $42,830 $40,000 8.5%

Preferred Stock $10,650 $10,000 10.6%

Common Equity $65,740 $32,000 25.3%

a. Calculate the firm's capital structures and WACCs based on both book and market values, and compare the two.

b. What appears to have happened to interest rates since the company was started?

c. Does the firm seem to be successful? Why?

d. What would be the implication of using a WACC based on book as opposed to market values? In other words, what kinds of mistakes might management make by using the book values?

7. Five years ago Hemingway Inc. issued 6,000 thirty-year bonds with par values of $1,000 at a coupon rate of 8%. The bonds are now selling to yield 5%. The company also has 15,000 shares of preferred stock outstanding that pay a dividend of $6.50 per share. These are currently selling to yield 10%. Its common stock is selling at $21, and 200,000 shares are outstanding. Calculate Hemingway’s market value based capital structure.

8. The Wall Company has 142,500 shares of common stock outstanding that are currently selling at $28.63. It has 4,530 bonds outstanding that won’t mature for 20 years. They were issued at a par value of $1,000 paying a coupon rate of 6%. Comparable bonds now yield 9%. Wall’s $100 par value preferred stock was issued at 8% and is now yielding 11%; 7,500 shares are outstanding. Develop Wall’s market value based capital structure.

9. The market price of Albertson Ltd.’s common stock is $5.50, and 100,000 shares are outstanding. The firm's books show common equity accounts totaling $400,000. There are 5,000 preferred shares outstanding that originally sold for their par value of $50, pay an annual dividend of $3, and are currently selling to yield an 8% return. Also, 200 bonds outstanding that were issued five years ago at their $1,000 face values for 30-year terms pay a coupon rate of 7%, and are currently selling to yield 10%. Develop Albertson's capital structure based on both book and market values.

10. Asbury Corp. issued 30-year bonds 11 years ago with a coupon rate of 9.5%. Those bonds are now selling to yield 7%. The firm also issued some 20-year bonds two years ago with an 8% coupon rate. The two bond issues are rated equally by Standard and Poors and Moody’s. Asbury’s marginal tax rate is 38%.

a. What is Asbury’s after-tax cost of debt?

b. What is the current selling price of the 20-year bonds?

11. The Dentite Corporation’s bonds are currently selling to yield new buyers a 12% return on their investment. Dentite’s marginal tax rate including both federal and state taxes is 38%. What is the firm’s cost of debt?

12. Kleig Inc.'s bonds are selling to yield 9%. The firm plans to sell new bonds to the general public and will therefore incur flotation costs of 6%. The company's marginal tax rate is 42%.

a. What is Kleig's cost of debt with respect to the new bonds? (Hint: Adjust the cost of debt formula to include flotation costs.)

b. Suppose Kleig also borrows directly from a bank at 12%.

1. What is its cost of debt with respect to such bank loans? (Hint: Would bank loans be subject to flotation costs?)

2. If total borrowing is 60% through bonds and 40% from the bank, what is Kleig's overall cost of debt? (Hint: Think weighted average.)

Cost of Preferred Stock: Example 13-4 (page 568)

13. Harris Inc.’s preferred stock was issued five years ago to yield 9%. Investors buying those shares on the secondary market today are getting a 14% return. Harris generally pays flotation costs of 12% on new securities issues. What is Harris’s cost of preferred financing?

14. Fuller, Inc. issued $100, 8% preferred stock five years ago. It is currently selling for $84.50. Assuming Fuller has to pay floatation costs of 10%, what is Fuller’s cost of preferred stock?

15. A few years ago Hendersen Corp issued preferred stock paying 8% of its par value of $50. The issue is currently selling for $38. Preferred stock flotation costs are 15% of the proceeds of the sale. What is Hendersen's cost of preferred stock?

16. New buyers of Simmonds Inc. stock expect a return of about 22%. The firm pays flotation costs of 9% when it issues new securities. What is Simmonds’ cost of equity (Hint: This problem is very simple since we don’t have to estimate the investors’ return.)

a. From retained earnings?

b. From new stock?

17. Klints Inc. paid an annual dividend of $1.45 last year. The firm’s stock sells for $29.50 per share, and the company is expected to grow at about 4% per year into the foreseeable future. Estimate Klints’ cost of retained earnings.

Cost of RE and New Stock: Examples 13-6 and 13-8 (pages 570 and 572)

18. The Pepperpot Company's stock is selling for $52. Its last dividend was $4.50, and the firm is expected to grow at 7% indefinitely. Flotation costs associated with the sale of common stock are 10% of the proceeds raised. Estimate Pepperpot's cost of equity from retained earnings and from the sale of new stock.

19. The Longlife Insurance Company has a beta of .8. The average stock currently returns 15% and short-term treasury bills are offering 6%. Estimate Longlife's cost of retained earnings.

20. The Longlife Insurance Company of the preceding problem has several bonds outstanding that are currently selling to yield 9%. What does this imply about the cost of the firm's equity?

21. Hammell Industries has been using 10% as its cost of retained earnings for a number of years. Management has decided to revisit this decision based on recent changes in financial markets. An average stock is currently earning 8%, treasury bills yield 3.5%, and shares of Hammell’s stock are selling for $29.44. The firm just paid a dividend of $1.50, and anticipates growing at 5% for the foreseeable future. Hammell’s CFO recently asked an investment banker about issuing bonds and was told the market was demanding a 6.5% coupon rate on similar issues. Hammell stock has a beta of 1.4. Recommend a cost of retained earnings for Hammell.