Question
In: Finance
Problem Solving WACC Equity Information 50 million shares $80 per share Beta = 1.11 Market risk...
Problem Solving WACC
Equity Information
- 50 million shares
- $80 per share
- Beta = 1.11
- Market risk premium = 7%
- Risk-free rate = 2%
Debt Information
- $1 billion in outstanding debt (face value)
- Current quote = 108
- Coupon rate = 9%, semiannual coupons
- 15 years to maturity
- Tax rate =35%
- What is the cost of equity? [K]
- What is the before-tax cost of debt? [L]
- What is the WACC?[M]
Solutions
Expert Solution
According to CAPM, cost of equity = Risk free rate + Beta*(Market risk premium)
Therefore, Cost of Equity(K) = 2 + 1.11*(7)
= 9.77%
Current quote of 108 indicates that the Bond is trading at 108% of par value
Therefore, Price or Present value of Bond = 108%*$1 billion
= $1.08 billion
Since coupons are paid semiannually, number of periods to maturity = 15*2 =30
Semiannual coupon payments = (9%/2)*$1 billion
= $0.045 billion
Cost of Debt is calculated in excel below
Market value of Equity = 50 million *$80
= $4000 million or $4 billion
Market value of Debt = $1.08 billion
Weight of Equity = Market value of Equity/(Market value of Equity + Market value of Debt)
= 4 billion/(4 billion + 1.08 billion)
= 4 billion/5.08 billion
= 0.78740
Weight of Debt = 1-Weight of Equity
= 0.21260
WACC = Cost of equity*Weight of Equity+ Cost of Debt*Weight of Debt*(1-tax rate)
= 9.77*0.78740 + 8.07*0.21260*(1-0.35)
jeff jeffy answered 2 years agoRelated Solutions
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