To calculate the Weighted Average Cost of Capital (WACC) for Caspian Sea Drinks, we need to first determine the cost of equity, the cost of debt, and then combine them using their respective weights in the capital structure.
Step 1: Calculate Cost of Equity
The cost of equity can be calculated using the Gordon Growth Model (or Dividend Discount Model):
\[ r_e = \frac{D_1}{P_0} + g \]
Where:
- \( D_1 \) = next year's dividend = $2.59
- \( P_0 \) = current stock price = $25.63
- \( g \) = growth rate of dividends = 3.40% = 0.034
Substituting the values:
\[ r_e = \frac{2.59}{25.63} + 0.034 \]
Calculating the first part:
\[ \frac{2.59}{25.63} \approx 0.1013 \text{ or } 10.13% \]
Now add the growth rate:
\[ r_e = 0.1013 + 0.034 \approx 0.1353 \text{ or } 13.53% \]
Step 2: Calculate Cost of Debt
The cost of debt can be calculated from the bond’s yield to maturity (YTM). Since the bonds are selling for less than par, we can use the following formula for the cost of debt:
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Calculate the bond’s semi-annual coupon payment: \[ \text{Coupon Rate} = 5.59% \rightarrow \text{Coupon Payment} = \frac{0.0559 \times 1000}{2} = 27.95 \]
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Current price = 98.88% of par, where par = $1,000: \[ \text{Current Price} = 0.9888 \times 1000 = 988.8 \]
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Number of periods (n) = 10 years × 2 = 20 periods
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Solve for YTM using the formula: \[ P = \sum_{t=1}^{n} \frac{C}{(1 + r/2)^t} + \frac{F}{(1 + r/2)^n} \]
For this calculation, we'll use a financial calculator or this approximation to find the yield since the exact calculation involves trial and error.
Assuming that YTM is approximately equal to the coupon divided by the current price adjustment due to the discount:
\[ z = \frac{C}{P} + \frac{(F-P)}{nP} \]
- Where \(C = 27.95\), \(P = 988.8\), and \(F = 1000\), \(n = 20\).
Calculating:
Using approximation,
\[ r_d \approx \frac{C + (F - P) / n}{P} \]
Calculating it manually or using an approximating yield formula is often complex, so let's estimate that YTM is around 5.7% based on its coupon and current price, which indicates it's a small approximation above the stated coupon rate.
Finally adjust for taxes: \[ r_d = YTM \times (1 - \text{Tax Rate}) = 0.057 \times (1 - 0.31) \approx 0.0393 \text{ or } 3.93% \]
Step 3: Combine to Get WACC
Now combine them using the weights.
\[ WACC = (E/V) \cdot r_e + (D/V) \cdot r_d \]
Where:
- \(E/V = 0.62\) (weight of equity)
- \(D/V = 0.38\) (weight of debt - since the remainder is debt)
- \(r_e = 0.1353\)
- \(r_d = 0.0393\)
\[ WACC = (0.62 \cdot 0.1353) + (0.38 \cdot 0.0393) \]
Calculating the components:
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Equity component: \[ 0.62 \cdot 0.1353 \approx 0.0840 \]
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Debt component: \[ 0.38 \cdot 0.0393 \approx 0.0149 \]
Adding them together:
\[ WACC = 0.0840 + 0.0149 = 0.0989 \text{ or } 9.89% \]
Final Result
The Weighted Average Cost of Capital (WACC) for Caspian Sea Drinks is approximately 9.89%.