Exercise-WACC

1. Given the following information for Dunhill Power Company, find the WACC. Assume
the company’s tax rate is 35%

Debt: 3,000 of 8 % coupon bonds outstanding, $1,000 par value, 20 years

to maturity, selling for $1,030, the bonds make semiannual
payments.
Preferred stocks: 13,000 shares of 7% dividend payment, par is $100, currently
selling for $108 per share with flotation cost of $3 per share.
Common stocks: 90,000 shares outstanding, selling for $45 per share, the beta is 1.2.
Market: 13% market return, and 6% risk free rate.

Solution:
1. Cost of each source of fund:

rd → Find yield to maturity of bonds

Number of period = 20*2 = 40 periods
Coupon payment = (8%*1000)/2 = $40 per periods
40 40 40 1000
1,030 = 1
+ 2
+ ⋯+ 40
+
(1 + 𝑌𝑚 ) (1 + 𝑌𝑚 ) (1 + 𝑌𝑚 ) (1 + 𝑌𝑚 )40

𝑌𝑚 = 3.85% / period → 7.70% / year

rps = Dividend per share / Price after Flotation cost

= (7%*100) / (108-3) = 7/105 = 6.67%

rs = rRF + beta (rM – rRF)

= 6% + 1.2 (13% - 6%) = 14.40%
2. Weight of each source of funds
Debt = 3,000 * 1,030 = 3,090,000 Wd = 3,090,000 / 8,544,000 = 36.17%
PS = 13,000 * 108 = 1,404,000 WPS = 1,404,000 / 8,544,000 = 16.43%
CS = 90,000 *45 = 4,050,000 WCS = 4,050,000 / 8,544,000 = 47.40%
Total Capital = 8,544,000

WACC = Wd rd (1-T) + WPS rPS + WCS rCS

= (36.17%*7.7%*(1-0.35)) + (16.43%*6.67%) + (47.40%*14.40%)
= 9.73%