1. Lecture 14
WACC Calculation

2. Topic covered in this lecture
Numerical example
Variables needed to calculate WACC
Cost of debt
Cost of equity
Cost of preferred equity
Market value capital structure weights
WACC
Practice question

3. Numerical Example # shares = 100,000 Dividend per share = $1.5
Debt
# bonds = 5,000
Coupon rate = 8% per annum
Payments = Semi-annual
Face value = $1,000
Bond price = $976.87
Time to maturity = 6 years
Common Equity
# shares outstanding = 2,000,000
Price per share = $2.50
Beta = 1.5
Risk-free rate = 3%
Market return = 7%
Preferred Equity
# shares = 100,000
Dividend per share = $1.5
Price per share = $10.50

4. Variables needed to calculate WACC
WACC = wCSRCS + wPSRPS + wDRD(1 – T)
To use this formula, we will need the following data:
wCS = capital structure weight on common equity
wPS = capital structure weight on preferred equity
wD = capital structure weight on debt
RCS = cost of capital on common equity
RPS = cost of capital on preferred equity
RD = cost of capital on debt
T = marginal corporate tax rate

5. Cost of Debt # bonds = 5,000 Coupon rate = 8% per annum
Payments = Semi-annual
Face value = $1,000
Bond price = $976.87
Time to maturity = 6 years
Coupon payment = 0.08 x $1,000 / 2 = $40
Number of coupon payments remaining = 6 x 2 = 12
PMT = -40
FV = -1000
PV =
N = 12
COMP I/Y
Cost of debt = Bond yield = RD = x 2 = = =8.5%

6. Cost of Common Equity # shares outstanding = 2,000,000
Price per share = $2.50
Beta = 1.5
Risk-free rate = Rf = 3%
Market return E(Rm) = 7%
Using SML, we have
RCS = Rf + Beta(E(Rm) – Rf)
= (0.07 – 0.03)
= 0.09
Cost of common equity = RCS = 0.09 = 9%

7. Cost of Preferred Equity
# shares = 100,000
Dividend per share = $1.5
Price per share = $10.50
Cost of preferred equity
= preferred equity yield
= RPS
= Dividend per share / Price per share
= 1.5/10.5
= = %

8. Capital Structure Weights
Weight on financing i = MV(financing i) / MV(Total Assets) Market value of debt = MV(Debt) = Bond price x # bonds = $ x 5,000 = $4,884, Market value of common equity = MV(Common Equity) = Share price x # shares = $2.50 x 2,000,000 = $5,000,000 Market value of preferred equity = MV(Preferred Equity) = Preferred share price x # preferred shares = $10.50 x 100,000 = $1,050,000

9. Capital Structure Weights (cont.)
MV(Total Assets) = MV(Debt) + MV(Common equity) + MV(Preferred equity) = $4,884, $5,000,000 + $1,050,000 = $10,934, Weight on Debt = MV(Debt) / MV(Total Assets) = $4,884, / $10,934, = Weight on Common Equity = MV(Common Equity) / MV(Total Assets) = $5,000,000 / $10,934, = Weight on Preferred Equity = MV(Preferred Equity) / MV(Total Assets) = $1,050,000 / $10,934, =

10. WACC = wCSRCS + wPSRPS + wDRD(1 – T)
WACC = ( x 0.09) + ( x ) + ( x x (1 – 0.4)) = =
= %

11. Three Cheers for Practice Hip Hip Hurray!
ABC, Inc.’s capital structure is made up of debt, common equity and preferred equity. The company has 10,000 coupon bonds outstanding, each with a maturity of 10 years, face value of $1,000, and a coupon rate of 6%. Coupons are paid quarterly but interest is compounded semi-annually. The yield on this bond issue is 5.5%. There are 1 million common shares outstanding, each at a price of $6.00. The beta on these common shares is 0.9, the risk-free rate is 2% and the expected market return is 8%. There are 50,000 preferred shares outstanding. The preferred shares pay a constant dividend of $1.00 and has an estimated yield of 6.25%. If the marginal corporate tax rate is 35%, what is ABC’s WACC?

12. Check Answers
Cost of debt = RD = Cost of common equity = RCS = Rf + Beta(Rm – Rf) = (0.08 – 0.02) = Cost of preferred equity = RPS = MV(Debt) = $1, x 10,000 = $10,411, MV(Common Equity) = $6 x 1,000,000 = $6,000,000 MV(Preferred Equity) = $16 x 50,000 = $800,000 MV(Total Assets) = $17, wD = wCS = wPS = WACC = = 5.03%

13. End of Lesson 14 on WACC Calculation