Question

What is ABC Inc.'s effective annual WACC given the following information?

ABC has no outstanding preferred stock

ABC does not pay any dividends

ABC has one issue of 10,000 bonds outstanding, each priced at $738.83. The bonds have a face value of $1000, pay semi-annual coupons at a rate of 9% APR compounded semi-annually, and mature in 15 years. The next coupon payment is 6-months from today.

ABC has 1,000,000 common stock shares outstanding, each priced at $16 per share. The stock has a CAPM β =1.3

Risk-free return is 2% and the expected return of the market is 10%.

The firm faces a 28% tax rate

Answer 1

Solution :-

Semiannual Coupon Amount = $1,000 * 9% * 6 / 12 = $45

Semiannual Period = 15 * 2 = 30

Annual Yield = 6.50% * 2 = 13.00%

Now After tax Cost of Debt ( Kd ) = 13.00% * ( 1 - 0.28 ) = 9.36%

Cost of Equity ( ke ) = Rf + Beta * ( Rm - Rf )

= 2% + 1.30 * ( 10% - 2% )  

= 12.4%

Value of Equity = 1,000,000 * $16 = $16,000,000

Value of Debt = 10,000 * $738.83 = $7,388,300

Total Value = $16,000,000 + $7,388,300 = $23,388,300

Now Weight of Debt = ( $16,000,000 / $23,388,300 ) = 0.6841 = 68.41%

Weight of Equity = 100% - 68.41% = 31.59%

Now WACC = ( We * Ke ) + ( Wd * Kd )

= ( 68.41% * 9.36% ) + ( 31.59% * 12.40% )

= 10.32%

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