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Corporate Finance Homework

This document summarizes the calculation of the weighted average cost of capital (WACC) for Saunders Investment Bank. It provides the values and weights of various financing instruments including bonds, zero coupon bonds, preferred stock, and common stock. It then calculates the pretax and aftertax costs of debt for bonds and zero coupon bonds. Finally, it calculates the WACC as 8.86% based on the costs and weights of the different sources of financing.

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Nguyen Doan Thanh Ha
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103 views3 pages

Corporate Finance Homework

This document summarizes the calculation of the weighted average cost of capital (WACC) for Saunders Investment Bank. It provides the values and weights of various financing instruments including bonds, zero coupon bonds, preferred stock, and common stock. It then calculates the pretax and aftertax costs of debt for bonds and zero coupon bonds. Finally, it calculates the WACC as 8.86% based on the costs and weights of the different sources of financing.

Uploaded by

Nguyen Doan Thanh Ha
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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BTVN Buổi 2

11.
Calculating Cost of Debt:
Shanken Corp. issued a 30-year, 5.9 percent semiannual bond 6 years ago. The bond
currently sells for 108 percent of its face value. The company’s tax rate is 35 percent.
a. What is the pretax cost of debt?
1 − (1 + Rb )−T
]+
FV
P = C[
Rb (1 + Rb )T
FV = $1000
P = 108%×$1000 = $1080

5.9% × $1000
C= = $29.5
2
Rb
Semiannual → and T ×2
2
1 − (1 + Rb ÷ 2)−6×2
]+
1000
1080 = 29.5[
Rb ÷ 2 (1 + Rb ÷ 2)6 × 2
⟹ Rb = 0.0437
Pretax cost of debt is 4.37%.
b. What is the aftertax cost of debt?

Rb2 = Rb1 × (1 − tax rate) = 0.0437 × (1 − 35%) = 2.84%


c. Which is more relevant, the pretax or the aftertax cost of debt? Why?

12.
12. Preferred Stock and WACC The Saunders Investment Bank has the following
financing outstanding. What is the WACC for the company?
Debt: 50,000 bonds with a coupon rate of 5.7 percent and a current price quote of 106.5;
the bonds have 20 years to maturity. 200,000 zero coupon bonds with a price quote of

BTVN Buổi 2_Đoan Thanh 1


17.5 and 30 years until maturity.
Bond = 50,000 ×106.5%×$1000 = $53,250,000

Zero coupon bond = 200,000 ×17.5%×$1000 = $35,000,000

Preferred stock: 125,000 shares of 4 percent preferred stock with a current price of $79,
and a par value of $100.

Preferred stock = 125,000 × $79 = $9,875,000

Common stock: 2,300,000 shares of common stock; the current price is $65, and the
beta of the stock is 1.20.

Common stock = 2,300,000 × $65 = $149,500,000


Market:

The corporate tax rate is 40 percent, the market risk premium is 7 percent, and the
risk-free rate is 4 percent.

Value Wi%

Bond $53,250,000 21.50429076

Zero coupon bond $35,000,000 14.13427562

Preferred stock $9,875,000 3.987884907

Common stock $149,500,000 60.37354871

Total $247,625,000

Cost of capital:

Bond:
1 − (1 + Rb )−T
]+
FV
P = C[
Rb (1 + Rb )T
FV = $1000

P = $1000 ×106,5% = $1,065

C = $1000 × 5.7% = $570

1 − (1 + Rb ÷ 2)−40
]+
1000
1, 065 = 57 ÷ 2[
Rb ÷ 2 (1 + Rb ÷ 2)40
⟹ Rb = 0.0517
∗
Aftertax: Rb = Rb × (1 − tax rate) = 0.0517 × (1 − 0.4) = 0.031
Zero coupon bond:
FV
BTVN Buổi 2_Đoan Thanh 2
FV
P=
(1 + RB )T
P = $1000 ×17.5% = $175

FV = $1000
1000
175 =
(1 + RZB ÷ 2)60
⟹ RZB = 0.059
∗
Aftertax: RZB = RZB × (1 − tax rate) = 0.059 × (1 − 0.4) = 0.0354
Common stock:

Rs = Rf + β(Rm − Rf )
Rs = 0.04 + 1.2 × 0.07
⟹ Rs = 0.124
Preferred stock:
Dp
Rp =
P
P = $79

Dp = 4%×$100 = 4
4
Rp = = 0.0506
79
WACC

RW ACC = WD RD (1 + tc %) + WP RP + WS RS
RW ACC = 5.06% × 3.99% + 12.4% × 60.37% + 3.54% × 14.13% +
3.1% × 21.5% = 8.86%

BTVN Buổi 2_Đoan Thanh 3

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