Cost Of Capital Case Study

WEIGHTED AVERAGE COST OF CAPITAL
1. Calculate the current cost of capital of Secure and Safe on a weighted average basis
Capital structure
Type Details
$50,000,000 bonds 5.5% coupon
$20,000,000 preferred stock Par value $50 per share Dividend $2.75 per share p.a
$25,000,000 book value of common stock Cost of capital is 12%

Firm’s marginal tax rate is 30%.
Cost of debt (issuance of bonds)
According to the book Finance for Managers (2015), we get the real cost of debt by taking out the tax liability. After-Tax Cost of Debt = rd − (rd × T) = rd × (1 − T)
Where rd refers to before tax return and T is the corporate tax rate.
Therefore, after tax cost of debt for The Secure and Safe Waste Management Company is;
5.5% x (1-30%) = 0.055 x (1-0.3)
Calculate the cost of capital of the company assuming the $45 million-dollar bond issue with a 4.5% coupon is approved.
Additional capital of $45 million-dollar bond issue with a 4.5% coupon
After-tax cost of additional debt (issuance of bonds)
Additional cost = rd × (1 − T)
Where rd refers to before tax return and T is the corporate tax rate.
i) Additional cost after tax = 4.5% X (1-30%) = 0.045 X 0.7 = 0.0315 = 3.15% ii) Market value of additional debt = $45 million
Total market value of IPO = $1,075 million + $45 million = $1,120 million iii) Weight calculation;
Percentage of; Calculation Weight by %
Bonds
Additional bond 50 million / 1,120 million
45 million / 1,120 million 4.46
4.02
Preferred stock 1,000 million / 1,120 million 89.29
Common stock 25 million / 1,120 million 2.23
Total 100

iv) New WACC calculation
WACC = (% of debt) (After-tax cost of debt) + (% of preferred stock) (cost of preferred stock) + (% of common stock) (cost of common