Assignment no 8 Name :Muhammad zahoor Section :bba6a MIS ID :25916 Subject :finance management |Assignment # 8 1. Suppose stock in Watta Corporation has a beta of .80. The market risk premium is 6 percent, and the risk-free rate is 6 percent. Watta’s last dividend was $1.20 per share, and the dividend is expected to grow at 8 percent indefinitely. The stock currently sells for $45 per share. Suppose Watta has a target debt-to-equity ratio of 50 percent. It’s cost of debt is 9 percent before taxes. If the tax rate is 35 percent, what is the WACC? Given data: Beta B = 0.80 Risk Premium = 6% Risk free rate R = 6% Dividend D 1.20$ Growth rate g = 8% Selling price P = 45$ Debt-to-equity ratio = 50% Cost of debt Kp = 9% Tax = 35 % To Find: WACC =? Solutions: Using the SML, we can write Re =R;:+ B [Ru — Re] Re = 0.06 + 0.80 [0.06] Re = 0.06 + 0.048 Re = 0.108 Ry = 10.8% By dividend growth approach, mye Phy i P g _ Do(1 +9) . P, _ 1.20 (1 + 0.08) +008 eS 45 , _ 1.20(1.08) zean B45 , 1.296 2 =a + 0.08 K, = 0.028 + 0.08 Kz = 0.108 Scanned with CamScanner ‘Scanned with CamScannerKp = 10.8% WACC = (Wz X Kg) + (Wp X Kp(1 —T)) WACC = (2/3 x 0.108) + (1/3 x 0.09(1 — 0.35)) WACC = (0.072) + (0.03 « (0.65)) WACC = (0.072) + (0.0195) WACC = 0.0915 WACC = 9.15% 2. Given the following information for Evenflow Power Co., find the WACC. Assume the company’s tax rate is 35 percent. Debt: 8,000 6.5 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 92 percent of par; the bonds make semi-annual payments. Common stock: 250,000 shares outstanding, selling for $57 per share; the beta is 1.05. Preferred stock: 15,000 shares of 5 percent preferred stock outstanding, currently selling for $93 per share. Market: 8 percent market risk premium and 4.5 percent risk-free rate. Solution: WACC =? WACC = (Wy X Kz) + (Wp X Kp) + (Wp X Kp(1 —T)) Amount of common equity — 250,000 * 57 — 14,250,006 Amount of preferred stock = 15,000 * 93 = 1,395,000 Amount of Debt = (1,000 * 0.92) * 8,000 = 7,360,000 We; =? We — Amount of common equity Total Amount W, = 14,250,000 B 14,250,000 + 1,395,000 + 7,360,000 _ 14,250,000 E 23,005,000 We= 0.62 Wp=? Scanned with CamScanner ‘Scanned with CamScannerP Wp=? Ke=? Kp=? Kp=? P, = CP _ Amount of preferred equity 1 a+YTMy Total Amount _ 1,395,000 We = 23,005,000 Wp = 0.06 _ Amount of Debt > “Total Amount __ 7,360,000 > 23,005,000 Wp= 0.32 Re =Rr+ B [Ru — Re] Rg = 0.045 + 1.05 [0.08] Re = 0.045 + 0,084 Rg = 0.129 Re= 12.9% K, = wiS _ 5% +100 1 + aoa YTM MV layyrMy Scanned with CamScanner ‘Scanned with CamScanner1 1 _ ~ (+ YTM/2)? 1 | Po = CP/2 YTM/2 + MV yTM ay At7% 1- “0.07/27? aap — | P, = 65/2 + 1000 ° / ~ 007/2..— (1 + 0.07/2)20*2 1 a0 laa = 32.5 + CC | Po = 32 “0.035. (+0. L— “ G035)" aay ae | = 325 Po —ooss | * 1000 (1.035)#° P, = 32.5 1 3555 +1000 _— 0.035 3.959 1 — 0.2526 Py = 32.5 oe + 1000[0.2526] 0.035 0.7474 Py = 32.5 [ | + 252.6 0.035 Py = 32.5 [21.35] + 252.6 Py = 694 + 252.6 Po = 946.6 At 12% 1-—_1 __ (1 + 0.12/2)20%2 | 1 Py = 65/2 |————""*"_| + 1000 | ° / 0.12/2 (1 + 0.12/2)20%2 1 ee ee (1 + 0.06) Py = 32.5 |_—————_ + 1000 —4--| ° 0.06 (1 + 0.06)*° - ao Py = 32.5 |———_—_| + 1000 | 0.06 (1.06)*° Scanned with CamScanner ‘Scanned with CamScanner1 1-7938 1 _ 10.28 = 32.5 |——""] + 1000 |——_ ee | 0.035 1000 | 028 1 — 0.0973 Py = 32.5 [ | + 1000[0.0973] 0.9027 Py = 32.5 [ | +973 0.06 Py = 32.5 [15.045] + 97.3 Po = 488.96 + 97.3 Py = 586.26 Interpolation [0.07 946-6) a|x YTM 920 5 c 0.12 586.26 Als ale 26.6 360.34 0.05 x 26.6 = ————_ = 0,0037 360.34 Ky = 0.07 +X xX 0.0 > Kp = 0.07 + 0.0037 = 0.0737 Kp = 7.37% WACC = (Wz X Kz) + (Wp X Kp) + (Wp X Kp(1 —T)) WACC = (0.62 x 0.129) + (0.06 x 0.054) + (0.32 x 0.0737(1 — 0.35)) WACC = 0.07998 + 0.00324 + (0.32 x 0.0737(0.65)) WACC = 0.07998 + 0.00324 + (0.32 x 0.047905) WACC = 0.07998 + 0.00324 + 0.01533 WACC =0.09855 WACC = 9.85% 3. Gaggle Internet, Inc. is evaluating its cost of capital under alternative financing arrangements. In consultation with investment bankers, Gaggle expects to be able to issue new debt at par with a coupon rate of 8% and to issue new preferred stock with a $2.50 per share dividend at $25 a share. The common stock of Gaggle is currently Scanned with CamScanner ‘Scanned with CamScannerselling for $20.00 a share. Gaggle expects to pay a dividend of $1.50 per share next year. Market analysts foresee a growth in dividends in Invest stock at a rate of 5% per year. Gaggle' marginal tax rate is 35%. a. If Gaggle raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Gaggle's cost of capital? If Gaggle raises capital using 30% debt, 5% preferred stock, and 65% common stock, what is Gaggle’s cost of capital? Solution: b. Ke=? By dividend growth approach, Kp =—+ E P, g 1.5 Kz = aaa 0.05 Kz = 0.075 + 0.05 Ky = 0.125 Ky = 12.5% Kp=? n= D P P, 25 35 K, = 0.1 K, = 10% Kp = 8% a) Cost of Capital =? if, 45% debt, 5% preferred stock, and 50% common stock were used: WACC = (W; x K;) + (Wp X Kp) + (Wp X Kp(1 —-T)) WACC = (0.5 x 0.125) + (0.05 x 0.1) + (0.45 x 0.08(1 — 0.35)) WACC = 0.0625 + 0.005 + (0.45 x 0.08(0.65)) WACC = 0.0625 + 0.005 + (0.45 x 0.052) WACC = 0.0625 + 0.005 + 0.0234 WACC = 0.0909 =9.09% b) Cost of Capital =? if, Gaggle raises capital using 30% debt, 5% preferred stock, and 65% common stock WACC = (W; X Kz) + (Wp X Kp) + (Wp X Kp(1 —T)) WACC = (0.65 x 0.125) + (0.05 x 0.1) + (0.3 x 0.08(1 — 0.35)) Scanned with CamScanner ‘Scanned with CamScannerWACC = 0,08125 + 0.005 + (0.3 x 0.08(0.65)) WACC = 0.08125 + 0.005 + (0.3 x 0.052) WACC = 0.08125 + 0.005 + 0.0156 WACC = 0.10185=10.18% Scanned with CamScanner ‘Scanned with Camscanner