Question

Given the following information for ONAIR Co., find the WACC. Assume the company’s tax rate is 35 percent. Debt 10,000, 5% semi-annual payment coupon bonds outstanding. $1,000 par value, 30 years to maturity. Selling for 98% of par value. Common Stock 500,000 shares outstanding, selling for $70 per share, the beta is 1.2 Market 8% market risk premium and 4% risk-free rate

Answer 1

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

MV of equity=70*500000

=35000000

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

MV of Bond=1000*10000*0.98

=9800000

MV of firm = MV of Equity + MV of Bond

=35000000+9800000

=44800000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 35000000/44800000

W(E)=0.7813

Weight of debt = MV of Bond/MV of firm

Weight of debt = 9800000/44800000

W(D)=0.2188

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 4 + 1.2 * (8)

Cost of equity% = 13.6

Cost of debt

K = Nx2

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

k=1

K =30x2

980 =∑ [(5*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^30x2

k=1

YTM = 5.1313566795

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

After tax cost of debt = 5.1313566795*(1-0.35)

= 3.335381841675

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

WACC=3.34*0.2188+13.6*0.7813

WACC =11.36%