Kuhn Co. is considering a new project that will require an initial investment of $4 million. It has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. Kuhn has noncallable bonds outstanding that mature in 15 years with a face value of $1,000, an annual coupon rate of 11%, and a market price of $1, 555.38. The yield on the company\'s current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividend of $9 at a price of $92.25 per share. You can assume that Jordan does not incur any flotation costs when issuing debt and preferred stock. Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $22.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 3% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 8.7%, and they face a tax rate of 40%. Determine what Kuhn Company\'s WACC will be for this project.
TO calculate the WACC we need to calculate the cost of individual items of debt, preferred stock and equity
Weight of debt = Wd = 0.45
Weight of preferred stock = Wp= 0.04
Weight of common equity = We =0.51
Cost of debt = yield to maturity = rate(nper,pmt,pv,fv) in excel where nper =15,pmt = 0.11*1000 =100, pv = 1555.38 and fv =1000
Hence yield to maturity =rate(15,110,-1555.38,1000) = 4.7422%
The post tax cost of debt = YTM *(1-tax rate ) = 4.7422%*(1-0.4) = 2.85%
Cost of debt (post tax) = Rd = 2.85%
Cost of preferred stock = Rp = 9/92.25 = 9.756% = 9.76%
Cost of Common equity = Re = D1/(P0-F) + g
where D1 = 2.78, P0 = 22.35, F = 0.03*22.35 = 0.6705 and g = 0.087
Hence Re = 2.78/(22.35-0.6705) + 0.087 = 21.52%
Hence WACC = We*Re + Wd* Rd + Wp* Rp = 0.51*21.52 + 0.45*2.85 + 0.04*9.76 = 12.648 = 12.65%
Homework Sourse