the rio rancho corporation financed a $10 million expansion by borrowing $2 million from israel discount...

the rio rancho corporation financed a $10 million expansion by borrowing $2 million from israel discount bank at an interest rate of 4.75% per year. in addition, the company issued bonds to the public with a face value of $8 million that have both a coupon rate and yield to maturity of 6.75%. if the company's tax rate is 38%, calculate the WACC of this expansion

Expert Solution

Amount borrowed from Isareal discount bank =   $2,000,000
Before tax Cost of debt =   4.75%
After tax cost of debt = Before tax cost*(1-tax rate)
4.75%*(1-38%)
2.945%

Bonds issued for   $8,000,000
Coupon rate and both YTM is   6.75%
both are same. So Bonds value is equal to face value
After tax cost of debt = Before tax cost*(1-tax rate)
6.75%*(1-38%)
4.185%

Weight of Loan = 2000000/(2000000+8000000)=   0.2
Weight of Bonds =8000000/(2000000+8000000)=   0.8


WACC = (weight of loan* cost of debt) + (weight of bonds * cost of debt)
(0.2*2.945%)+(0.8*4.185%)
0.0394   or 3.94%

So WACC of expansion is 3.94%

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