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Country Markets has an unlevered cost of capital of 11.45 percent, a tax rate of 35...

Country Markets has an unlevered cost of capital of 11.45 percent, a tax rate of 35 percent, and expected earnings before interest and taxes of $18,700. The company has $11,000 in bonds outstanding that have an 8 percent coupon and pay interest annually. The bonds are selling at par value. What is the value of WACC?

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Expert Solution

Value of unlevered firm = EBIT (1-tax rate) / cost of capital

= 18,700 (1-0.35) / 0.1145

= 18,700 (0.65) / 0.1145

= 12,155 / 0.1145

= $106,157.205

Value of levered firm= value of unlevered firm + tax × value of debt

= 106,157.205 + 11,000(0.35)

= 106,157.205 + 11,000 (0.35)

= 106,157.205 + 3,850

= $110,007.205

Value of equity = value of levered firm - value of debt

= 110,007.205 - 11,000

= $99,007.205

Return on equity = cost of unlevered firm + (cost of unlevered firm - cost of debt) × debt/equity × (1-tax rate)

= 0.1145 + (0.1145 - 0.08) × 11,000 / 99,007.205 × (1 - 0.35)

= 0.1145 + (0.0345) × 0.11 × 0.65

= 0.1145 + 0.00249

= 0.1170 or 11.70%

Weight of debt = 11,000 / 110,007.205 = 10%

Weight of equity = (1-weight of debt)

= (1 - 0.10)

= 90%

Wacc= Weight of debt × Cost of debt (1-tax rate) + weight of equity × cost of equity

= 0.10 × 8% (1-0.35) + 0.90 × 11.70%

= 0.10 × 8% (0.65) + 10.53%

= 0.10 × 5.2% + 10.53%

= 0.52% + 10.53%

= 11.05%

Therefore the WACC is 11.05%

jeff jeffy answered 2 years ago
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