Could Someone see if i calculated the following scenario correctly? I inculded all my calculations. You work
Question:
Could Someone see if i calculated the following scenario correctly? I inculded all my calculations.
You work for an investment banking firm and have been asked by management of Vestor Corporation (not real), a software development company, to calculate its weighted average cost of capital, to use in evaluating a new company investment. The firm is considering a new investment in a warehousing facility, which it believes will generate an internal rate of return of 11.5%. The market value of Vestor's capital structure is as follows:
(Source of Capital - Market Value) (Bonds - $10,000,000) (Preferred Stock - $2,000,000) (Common Stock - $8,000,000)
To finance the investment, Vestor has issued 20 year bonds with a $1,000 par value, 6% coupon rate and at a market price of $950. Preferred stock paying a $2.50 annual dividend was sold for $25 per share. Common stock of Vestor is currently selling for $50 per share and has a Beta of 1.2. The firm's tax rate is 34%. The expected market return of the S&P 500 is 13% and the 10-Year Treasury note is currently yielding 3.5%.
Source of Capital
Market Value
Bonds$10,000,000 (weights 10,000,000/20,000,000= .5)
(Cost of capital 4.17%) (W*C = .5*4.17 = 2.08%)
Preferred Stock$2,000,000 (weights 2,000,000/20,000,000 = .10)
(Cost of capital 14.90%) (W*C = .10*14.90 = 1.49%)
Common Stock$8,000,000 (weights 8,000,000/20,000,000 =.40)
(Cost of Capital 10%) (W*C = .4*10%=4%)
WACC = Weighted average cost of capital = (Weight of debt * Cost of Debt) + (weight of common stock or equity * cost of common stock or equity) + (weight of preferred stock * cost of preferred stock)
WACC=2.08+1.49+4
WACC= 7.57%
Add bonds, preferred stock, and common stock to get the weights = $20,000,000
COST OF DEBT =Yield of the bond = Expected coupon on the bond / market price of the bond
(Coupon rate * face value of the bond) / market price of the bond
= (6% * $1000) / $950 = $60 / $950
= 0.06315
COST OF DEBT= 6.315%
after tax cost of debt = before tax cost * (1 - tax rate) =
6.315% * (1 - 34%) =
0.04168 =
4.168% =
AFTER TAX COST OF DEBT = 4.17%
COST OF EQUITY = Required rate of return on equity = Rf + (Rm - Rf) * Beta =
Risk free rate of return + (Market return - risk free rate of return) * beta
Risk free rate of return + (Market risk premium) * beta
Market risk premium is the premium expected to be earned for investing
Expected market return = S&P 500 is 13%
rate of return expected by equity = T note rate + (expected market return - T note rate) * beta =
3.5% + (13% - 3.5%) * 12 =
3.5% + 9.5% * 1.2 =
0.149 =
COST OF EQUITY = 14.90%
cost of preferred stock = Dividend per stock / Stock price =
= $2.5 per share / $25 per share =
COST OF PREFERRED STOCK = 10%
Vestor should go foreward with the warehouse investment