Hellman Industries is estimating the weighted average cost of capital of its new project. The company plan to finance this new project by 50 percent ordinary shares, 10 percent preference equity and rest by issuing debt. The return on FTSE 100 index is 11.4 percent and the 3 months’ treasury bills yield is 4%. The Hellman beta is 1.05. The average yield to maturity of Hellman semiannual coupon bonds is 8.3 percent. The Preference share are currently valued at £76, with a par value of £100 and an 8% dividend. The Hellman Industries is in the 40% marginal Tax bracket. a. Find the Pretax cost of Debt,

Question Completion:

a. Find the Pretax cost of Debt, cost of preference, and ordinary shares.

b. Calculate Hellman Pre- tax and after Tax WACC.

Hellman Industries

a) Pretax cost of debt = Yield on bonds = 8.3%

b) Cost of Common equity

= 11.77%

c) Cost of preferred stock

= 10.53%

d) Pre-tax WACC

= 10.3%

e) After-tax WACC

= 8.93%

Explanation:

a) Data and Calculations:

Weight of Common stock = 50%

Weight of Preferred stock = 10%

Weight of Debts (Bonds) = 40% (100% - 50% - 10%)

Market return on common stock = 11.4%

Risk-free return (treasury bills yield) = 4%

Beta = 1.05

Average yield to maturity of Hellman semiannual coupon bonds = 8.3%

Market price of Preferred stock = £76 per share

Par value of Preferred stock = £100

Dividend rate of Preferred stock = 8%

Dividend per share = £8 (£100 * 8%)

Cost of Preferred stock = £8/£76 * 100 = 10.53%

Marginal tax rate = 40%

a) Pretax cost of debt = Yield on bonds = 8.3%

After-tax cost of debt = 8.3% (1 - 0.4) = 4.98%

b) Cost of Common equity, Re = Risk Free Rate + Beta x (Market Return - Risk Free Rate) = 4% + 1.05 x (11.4% - 4%)

= 4% + 1.05 * 7.4%

= 4% + 7.77%

= 11.77%

c) Cost of preferred stock = Dividend per share/Price * 100

= $8/$76 * 100

= 10.53%

d) Pre-tax WACC = 50% * 11.77% + 10% * 10.53% + 40% * 8.3%

= 5.885 + 1.053 + 3.32

= 10.258

= 10.3%

e) After-tax WACC = 50% * 11.77% + 10% * 10.53% + 40% * 4.98%

= 5.885 + 1.053 + 1.992

= 8.93%

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