Nevada Hydro is 40 percent debt-financed and has a weighted-average cost of capital of 9.7 percent:.

QUESTION

Nevada Hydro is 40 percent debt-financed and has a weighted-average cost of capital of 9.7 percent:Bankers Tryst Company is advising Nevada Hydro to issue $75 million of preferred stock at a dividend yield of 9 percent. The proceeds would be used to repurchase and retire common stock. The preferred issue would account for 10 percent of the preissue market value of the firm.Bankers Tryst argues that these transactions would reduce Nevada Hydros WACC to 9.4 percent:Do you agree with this calculation? Explain.
Preference issue will account for 10% of pre-issue market value of the firm Value of Preference Share to be issued = $75 million Pre-issue market value of the firm = $75 million / 0.1 = $750 million Value of Equity pre-issue of preference share = 60% * $750 million = $450 million Value of Debt pre-issue of preference share = 40% * $750 million = $300 million It is given that proceeds of preference share will be used to retire common stock Value of Common Stock post issuance of preference share and retirement = $450 million $75 million = $375 million New capital

of the firm post issuance of preference share and retirement of equity = ($375 + $300 + $75) million = $750 million Proportion of equity = $375 / $750 = 50% Proportion of Preference = $75 / $750 = 10% Proportion of Debt = $300 / $750 = 40% Hence WACC with tax rate at 35% (1 0.35) * (0.085) * (0.4) + (0.09) * (0.1) + (0.125) * (0.5) = 9.4% Hence the given solution is correct.

ANSWER:

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