Question
BLACKFRIDAY company is planning an expansion of its existing production capacity. The firm hired you as a consultant for the expansion project. Since you are
BLACKFRIDAY company is planning an expansion of its existing production capacity. The firm hired you as a consultant for the expansion project. Since you are a savvy project manager, you first decided to estimate the firms cost of capital based on the available data.
Data:
- Tax Rate: 40%
- Bond: Coupon rate 12%, Maturity Years 15, Present value $1150
- Preferred Stock: Dividend rate 10%, Par Value $100, Present Value $111 Common Stock: Market price $50, D0=$4.20, Dividend growth 5%, Beta 1.2, Treasury Bond yield 7%, Market risk premium 6%. When the firm uses Bond-yield+Premium method, the risk premium is 4%.
- Capital structure of ABC is as follows;
- Debt 30%, Common Equity 60%, Preferred Stock 10%
Next, you asked your assistant Mr.COUPON to give his opinion on the following burning questions;
ii. | Cost of bond of the company is as follows: a) Pre tax cost of bond - 12% b) Post tax cost of bond - 12% - 40% = 7.20% |
iii. | Cost of the firm's common stock: a) Based on historical data - 10% b) based on current market price - 100*10%/111 = 9.009% (This shall be used to evaluate future projects) |
1) What are the components of the WACC you calculated above to be blamed for higher WACC? What can be done to reduce the WACC further?
2) Should you use this WACC for all the projects? Why and why not?
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