Question

BEEber Inc. currently has 10,000 bonds outstanding. The bonds have a coupon rate of 8%, paid semi-annually, mature in 10 years, and are trading at $985 each. BEEber’s common stock currently sells for $20 per share and there are 750,000 shares outstanding.

The risk-free rate is 4.5%, the expected return on the market is 15%, and BEEber’s beta is equal to 2.0. The corporate tax rate is 40%. What is BEEber’s WAC?

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=20*750000

=15000000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*10000*0.985

=9850000

MV of firm = MV of Equity + MV of Bond

=15000000+9850000

=24850000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 15000000/24850000

W(E)=0.6036

Weight of debt = MV of Bond/MV of firm

Weight of debt = 9850000/24850000

W(D)=0.3964

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (expected return on the market - risk-free rate)

Cost of equity% = 4.5 + 2 * (15 - 4.5)

Cost of equity% = 25.5

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =10x2

985 =∑ [(8*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^10x2

k=1

YTM = 8.2229295211

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 8.2229295211*(1-0.4)

= 4.93375771266

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=4.93*0.3964+25.5*0.6036

WACC =17.35%