Question

Kuhn Co. is considering a new project that will require an initial investment of $20 million. It has a target capital structure of 58% debt, 6% preferred stock, and 36% 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 $1555.38. 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 $8 at a price of $95.70 per share. 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 $33.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 25%. What will be the WACC for this project? (Note: Round your intermediate calculations to two decimal places.)

Answer 1

Answer:

8?14%

Explanation:

Calculation for What will be the WACC for this project

First step is to calculate the Yield using financial calculator

N=15 years

FV=1,000

PV=-$1555.38

PMT=11%

CPT I/Y=5.48%%

Second step is to calculate After-tax cost of debt using this formula

After-tax cost of debt=Yield*(1-tax rate)

Let plug in the formula

After-tax cost of debt=5.48%*(1-25%)

After-tax cost of debt=5.48%*75%

After-tax cost of debt=4.11%

Third step is to calculate Cost of preferred stock using this formula

Cost of preferred stock=Dividend/Price

Let plug in the formula

Cost of preferred stock=8/92.25

Cost of preferred stock=8.67%

Fourth step is to Cost of common stock using this formula

Cost of common stock=Expected Dividend/(Price*(1-Flotation cost %))+Growth rate

Let plug in the formula

Cost of common stock=2.78/(33.35*(1-8%))+5.48%

Cost of common stock=2.78/(33.35*0.92)+5.48%

Cost of common stock=(2.78/30.68)+5.48%

Cost of common stock=9.06%+5.48%

Cost of common stock=14.54%

Now let calculate WACC

WACC=58%*4.11%+6%*8.67%+36%*14.54%

WACC=8.14%

Therefore What will be the WACC for this project is 8.14%