WACC Problem. The solution of the problem is below the question. I just have a couple questions on how the numbers were calculated. The problem does not state a future value and yet my professor got 1000, why is this? How was PMT caculated, where did he get the .6? In part D, how did he get .92 in the problem? when floatation is only 4% Lastly, for part F: how did he calculate 1.3573(300) = 420 for debt. where did the 1.3573 come from? And below that where did the 2 come from under market value, in the total equity column.

2. Cablevision Inc. has bonds with a coupon rate of 12% (assume annual payments) , and a maturity of 30 years. These bonds today are selling for $1392.73. Additionally, the firms beta is 1.2, the risk-free rate is 5 percent, and the expected market return is 13%. The firm has $300M of debt and $550M of Equity on its balance sheet. The firms stock price is $20/share, its current dividends are $1.50 per share, and these dividends are expected to grow at 7% per year. The book value of equity is $10/share. The firms tax rate is 40%. The flotation costs of bonds are 4%, and for stock issues it is 8%. The firm plans on satisfying 75% its equity needs internally and 25% of it externally.

a. Find the firms cost of debt.

b. Find the firms cost of internal equity using the CAPM.

c. Find the firms cost of internal equity using the dividend growth model

d. Find the firms cost of external equity using the dividend growth model

e. Find the firms cost of external equity using CAPM

f. Find the firms WACC using the dividend growth model for the firms costs of internal and external equity.

g. Find the firms weighted average cost of capital (WACC) using CAPM in calculating the firms costs of internal and external equity.

h. Under what assumptions would it be appropriate for the firm to use its WACC as the discount rate in evaluating its projects?

Solutions:

FV = 1000

N = 30

PV = -1392(0.96) = -1337

PMT = 120(.60) = 72

r_d = i? = 5%

r_e,int CAPM = 5+(13-5)1.2 = 14.60%

r_e, int = (1.5(1.07)/20)+0.07 = (1.605/20)+0.07 = 15.00%

r_e, ext. = (1.605/20(0.92))+0.07 = (1.605/18.4)+0.07 = 15.72%

From Div. growth

r_e-ext-re, int = 15.72-15 = 0.72

r_e,ext CAPM 14.60+0.72 = 15.32

Book value Market value

Debt 300 300(1.3573) = 419.16 = 420

Total equity 550*2= 1100

Internal equity 1100*.75= 825

External equity 1100*0.25= 275

Total capital 1520

W_d = 420/1520 = 0.28

We,int = 825/1520 = 0.54

We, ext = 275/1520 = 0.18

1.00

WACC = 0.28*5+0.54*15+0.18*15.72 = 12.33%

WACC = 0.28*5+0.54*14.60+0.18*15.32 = 12.04

Assumption 1: The firms target capital structure is same as the current capital structure

Assumption 2: The risk of the project is the same as the risk of the firm