Need help calculating the Weighted Average Cost of Capital (WACC)?

Question

I have a finance final tomorrow, and having trouble calculating the WACC. I have two take home problems, and was wondering if someone could explain how to solve these problems? I am not asking to be given the answers, that would not help me on the test, but just tell me how I would go about doing them in the easiest to understand way possible. I have another problem I need help with that I will also be posting. Again, not asking for answers, just explanations.

(1) The bond of Company ABC has 5 years to maturity. The bond’s coupon rate is 8% and it is selling at $950. The total value of the bonds is $20M. The company also has preferred stocks, which are worth $10M. The preferred stock pays a dividend of $1 a share and currently sells at $10 a share. The common stocks of the company are worth $30M. The beta of the common stock is 1.5, the market risk premium is 8%, the risk free rate is 6%, and the firm’s tax rate is 35%. What is the company’s WACC?

I only need help with this problem afterall, the other is an easier one I understand, so I will not be posting it most likely.

Answer 1

To compute r(wacc) we must know
1. after tax cost of debt, R(b) * (1-Tax)
2. the cost of equity R(s)
3. Proportions of debt & equity used by firm

These values can computed as:
1. The pretax cost of debt is 8%, so after tax rate would be:
8%*(1-0.35) = 5.2%
2. The cost of equity capital:
r(s) = R(f) + Beta*[R(m) - R(f)]
= 0.06+1.5*0.08
= 18%
3. The proportions of debt and equity are computed from the market values of debt and equity. Because the market value of the firm is $30M ($20M+$10M) the proportions of debt and equity are 20/30 and 10/30 respectively.

r(wacc) = [B/(B+S)]*r(b)*(1-tax)+ [S/B+S]*r(s)


= [(20/30)*0.052] + [(10/30)*0.18]
= 0.035+0.060
= 0.095

WACC = 9.5%

Answer 2

the required equity return ks=krf+beta(km-krf)
where krf is risk free rate, beta you have given, market return or risk premium is km.
So the wacc=20/60x0.08(1-taxrate)+10/60xcost of preferred+30/60xks.
cost of preferred=(10million/10x1)/10million=10% or 0.01 for calculation above in the formula.
So you have everything substitute and get the result since you didn't want the result. One question to you, a person who gets so many best answers why you need answers for such a simple problem?

Answer 3

Sorry I thought I could help you but maybe you can get help on moneychimp.com.