The Imaginary Products Co currently has debt with a market v

The Imaginary Products Co. currently has debt with a market value of $300 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $915.93 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $29. The preferred shares pay an annual dividend of $1.20. Imaginary also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 6 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?

Solution

Cost of debt:

Using financial calculator BA II Plus - Input details:

#

FV = Future Value =

-$1,000.00

PV = Present Value =

$915.93

N = Total number of periods = Number of years x frequency =

30

PMT = Payment = Coupon / frequency =

-$45.00

CPT > I/Y = Rate per period or YTM per period =

                     5.050

Convert Yield in annual and percentage form = Yield*frequency / 100 =

10.10%

Cost of debt = YTM x (1-Tax) =

6.06%

Cost of preferred:

Cost of preferred = Dividend / Market price of preferred

Cost of preferred = 1.20 / 29

Cost of preferred = 4.137931%

Cost of equity:

Given details

#

Existing growth rate = g =

6.00%

Expected dividend = D1 = D0*(1+g) =

2.20

Expected rate = r =

?

Flotation cost = f =

0.00

Current stock price = P0 =

20.00

Formula for calculating the Expected rate:

r = (D1/(P0-f))+g =

17.00%

---------------

Weights of each types of capital:

Particulars

Price

Quantity

Price x Quantity

Market value Weight in decimal

Debt

$915.93

                 327,536

       300,000,000.00

                                         0.470219

Preferred Share

$29.00

              2,000,000

          58,000,000.00

                                         0.090909

Equity

$20.00

            14,000,000

       280,000,000.00

                                         0.438871

Total

       638,000,000.00

Weighted cost of capital calculation:

WACC = Cost of equity x Weight of equity + Cost of preferred x Weight of preferred + After tax Cost of debt x Weight of Debt

WACC = 17.00% x 0.438871 + 4.137931% x 0.090909 + 6.06% x 0.470219

WACC = 10.686520%

OR

WACC = 10.69%

Using financial calculator BA II Plus - Input details:	#
FV = Future Value =	-$1,000.00
PV = Present Value =	$915.93
N = Total number of periods = Number of years x frequency =	30
PMT = Payment = Coupon / frequency =	-$45.00
CPT > I/Y = Rate per period or YTM per period =	5.050
Convert Yield in annual and percentage form = Yield*frequency / 100 =	10.10%
Cost of debt = YTM x (1-Tax) =	6.06%