Question

The current stock price for a company is $40 per share, and there are 6 million shares outstanding. The beta for this firms stock is 1, the risk-free rate is 4.4, and the expected market risk premium is 6.2%. This firm also has 280,000 bonds outstanding, which pay interest semiannually. These bonds have a coupon interest rate of 6%, 22 years to maturity, a face value of $1,000, and a current price of 1,026.81. If the corporate tax rate is 35%, what is the Weighted Average Cost of Capital (WACC) for this firm? (Answer to the nearest hundredth of a percent, but do not use a percent sign).

Answer 1

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

MV of equity=40*6000000

=240000000

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

MV of Bond=1000*280000*1.02681

=287506800

MV of firm = MV of Equity + MV of Bond

=240000000+287506800

=527506800

Weight of equity = MV of Equity/MV of firm

Weight of equity = 240000000/527506800

W(E)=0.455

Weight of debt = MV of Bond/MV of firm

Weight of debt = 287506800/527506800

W(D)=0.545

Cost of equity

As per CAPM

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

Cost of equity% = 4.4 + 1 * (6.2)

Cost of equity% = 10.6

Cost of debt

K = Nx2

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

k=1

K =22x2

1026.81 =∑ [(6*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^22x2

k=1

YTM = 5.7830653993

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

After tax cost of debt = 5.7830653993*(1-0.35)

= 3.758992509545

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

WACC=3.76*0.545+10.6*0.455

WACC =6.87%