Groepsopdracht 2 :

Gelieve tegen 15 december de volgende twee oefeningen op te lossen:

- Pampered Pets
- Jayhawks

Gelieve de oplossing per email op te sturen naar : eddy.laveren@ua.ac.be

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Pampered Pets, Incorporated is a nationwide pet grooming franchise. Its balance sheet contains
the following information:

Bonds ($ 1000 face value, 10% couipon, 10 years to maturity) $ 80 million

Preferred stock ($ 5 dividend, 1 million shares outstanding) $ 10 million
Common stock (6 million shares outstanding) $ 100 million

The bonds are selling at a price to yield 11% and pay interest annually. The preferred stock is
selling for $ 40 a share while the common stock is selling for $ 22 a share. The beta of the equity
is 1.4. The relevant Treasury security rate is5.5% and the S&P 500 is expected to return 14.8%.
The firm is in the 34% marginal tax bracket.

a) Calculate the after-tax cost of debt.

b) Calculate the after-tax cost of preferred stock.
c) Calculate the after-tax cost of common stock.
d) Calculate the firm’s weighted average cost of capital.
Solution:

a) Since the bonds are selling to yield 11%, k(d) = 11% * (1-0.34) = 7.26 %
b) k(p) = dividend / price = $ 5 / $ 40 = 12.5%
c) We can find the cost of common stock by applying CAPM as follows

k(c) = 5.5% + 1.4 * (14.8% - 5.5%) = 18.52 %

d) We need to first find the market value of each financing component in order to determine the
correct proportions. The market value of the debt can be found by discounting back the total
coupon payments and the maturity value at the yield-to-maturity as follows:

Total annual coupon payments = 0.10 * ($ 80 000 000) = $ 8 000 000

10
8000000 80000000
Bond market value = ∑ . )i
i = 1 (111
+
. )10
(111
= $ 75 289 600

The market value of the preferred stock is simply the price per share times the number of shares
outstanding, or $ 40 * 1 000 000 = $ 40 million.
The market value of the common stock is calculated in the same manner as that of the preferred
stock, so $ 22 * 6 000 000 = $ 132 million.

The proportions can now be calculated.

Market value Proportion Capital Cost

Bonds $ 75 289 600 0.30 7.26 %
Preferred stock $ 40 000 000 0.16 12.50%
Common stock $ 132 000 000 0.53 18.52%

WACC = 13.99 %