Qatar Airways wants to determine its weighted average cost of capital (WACC). They have a capital structure of 60% equity and 40% debt. They issued $1000 coupon bonds with a 7% coupon rate and 11 years to maturity, selling them at $945 with a flotation cost of $6 per bond. They use the Dividend Discount Model (DDM) to determine the cost of new issuance equity. The current stock price is $41 per share, the next year's expected dividend is $2.50 per share, and the dividend is expected to grow at a constant rate of 6% per year. The stock underpricing is $3, and the flotation cost is $2. The tax rate is 40%. We need to calculate the WACC.

1. Problem Description

Qatar Airways wants to determine its weighted average cost of capital (WACC). They have a capital structure of 60% equity and 40% debt. They issued $1000 coupon bonds with a 7$945 with a flotation cost of $6 per bond. They use the Dividend Discount Model (DDM) to determine the cost of new issuance equity. The current stock price is$41 per share, the next year's expected dividend is $2.50 per share, and the dividend is expected to grow at a constant rate of 6$3, and the flotation cost is $

2. The tax rate is 40%. We need to calculate the WACC.

2. Solution Steps

Step 1: Calculate the cost of debt ($r_d$).

The cost of debt is the yield to maturity (YTM) of the bond, adjusted for taxes.

First, determine the net proceeds from the sale of the bond. The bond sold for $945, and there was a$6 flotation cost, so the net proceeds are $945 -$6 = $

9

3

9. We need to find the YTM for a bond with a face value of $1000, a coupon rate of 7% (coupon payment of $70 per year), a market price of $939, and a maturity of 11 years. This can be calculated using financial calculator or spreadsheet software and we will denote the YTM as $YTM$.

By using online calculator, we get that $YTM$ is equal to 0.0785, or 7.85%.

The after-tax cost of debt is calculated as:

$r_d = YTM * (1 - tax rate)$

$r_d = 0.0785 * (1 - 0.40) = 0.0785 * 0.60 = 0.0471$ or 4.71%.

Step 2: Calculate the cost of equity ($r_e$).

The cost of equity is calculated using the Dividend Discount Model (DDM):

$r_e = \frac{D_1}{P_0 - Underpricing - Flotation Cost} + g$

Where:

$D_1$ = Expected dividend next year = $2.50

$P_0$ = Current stock price = $41

Underpricing = $3

Flotation Cost = $2

$g$ = Dividend growth rate = 0.06

$r_e = \frac{2.50}{41 - 3 - 2} + 0.06$

$r_e = \frac{2.50}{36} + 0.06$

$r_e = 0.0694 + 0.06 = 0.1294$ or 12.94%.

Step 3: Calculate the Weighted Average Cost of Capital (WACC).

$WACC = (Weight of Equity * Cost of Equity) + (Weight of Debt * Cost of Debt)$

$WACC = (0.6 * 0.1294) + (0.4 * 0.0471)$

$WACC = 0.07764 + 0.01884 = 0.09648$ or 9.65%.

3. Final Answer

The Weighted Average Cost of Capital (WACC) is 9.65%.