Question

5.​Calculate the WAAC with the following information:

​​Equity Information​​​​Debt Information

​​10,000 shares​​​​$200,000 in outstanding debt ​​​​​​​​​(face value)

​​$60 per share

​​Beta = 1.2​​​​​Current quote = 100

​​Market risk premium = 12%​​Annual coupon rate = 10%

​​Risk-free rate = 5%​​​​Tax rate = 20%

Answer 1

First we will calculate the cost of equity by CAPM model by the following formula:

Cost of equity = Risk free rate + Beta * Market risk premium

Given: Risk free rate = 5%, Beta = 1.2 and Market risk premium = 12%

Now, putting these values in the above formula, we get,

Cost of equity = 5 + (1.2 * 12)

Cost of equity = 5 + 14.4 = 19.4%

Now, we will calculate the weighted average cost of capital (WACC). The formula for weighted average cost of capital is:

WACC = E / V * r_e +   D / V * r_d * (1 - t)

where, E = Market value of equity = 10000 * $60 = $600000

D = Market value of debt = $200000

r_e = Cost of equity = 19.4% (as calculated above)

r_d = Cost of debt = 10%

V = E + D = $600000 + $200000 = $800000

t = tax rate = 20%

Now, putting these values in the WACC formula, we get,

WACC = (($600000 / $800000) * 19.4%) + (($200000 / $8000000) * 10% * (1 - 0.20))

WACC = (0.75 * 19.4%) + (0.25 * 10% * 0.80)

WACC = 14.55% + 2%

WACC = 16.55%