Wayne Industries currently has 50,000 of its 5% semi-annual coupon bonds outstanding (par value = 1000). The bonds will mature in 19 years and are currently priced at $1,120 per bond. The firm also has an issue of 1.5 million preferred shares outstanding with a market price of $30.00. The preferred shares offer an annual dividend of $2.40. Wayne Industries also has 4.5 million shares of common stock outstanding with a price of $17.50 per share. The firm is expected to pay a $1.20 common dividend 1 year from today, and that dividend is expected to increase by 5% per year forever. The firm typically pays floatation costs of 2% of the price on all newly issued securities. If the firm is subject to a 35% marginal tax rate, then what is the firm’s weighted average cost of capital?

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of common stock * cost of common stock)

market value of debt = bonds outstanding * market price per bond

market value of preferred stock = shares outstanding * market price per share

market value of common stock = shares outstanding * market price per share

total market value = market value of debt + market value of preferred stock + market value of common stock

weight of debt = market value of debt / total market value

weight of preferred stock = market value of preferred stock / total market value

weight of common stock = market value of common stock / total market value

cost of equity = (next year dividend / net proceeds per share) + growth rate.

net proceeds per share = price of share - flotation cost

cost of preferred stock = (annual dividend / net proceeds per share)

after tax cost of debt = YTM of bond * (1 - tax rate)

YTM is calculated using RATE function in Excel with these inputs :

nper = 19*2 (19 years to maturity with 2 semiannual coupon payments each year)

pmt = 1000 * 5% / 2 (semiannual coupon payment = face value * annual coupon rate / 2. This is a positive figure as it is an inflow to the bondholder)

pv = -1097.60 (net proceeds per bond = bond price - flotation cost = $1120 - ($1120 * 2%) = $1097.60. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

The RATE calculated is the semiannual YTM. To calculate the annual YTM, we multiply by 2.

after tax cost of debt = YTM * (1 - tax rate).

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