Question

The current stock price for a company is $49 per share, and there are 3 million shares outstanding. The beta for this firms stock is 1.4, the risk-free rate is 4.8, and the expected market risk premium is 5.6%. This firm also has 270,000 bonds outstanding, which pay interest semiannually. These bonds have a coupon interest rate of 8%, 24 years to maturity, a face value of $1,000, and an annual yield to maturity of 7%. If the corporate tax rate is 31%, 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

K = Nx2

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

k=1

K =24x2

Bond Price =∑ [(8*1000/200)/(1 + 7/200)^k]     +   1000/(1 + 7/200)^24x2

k=1

Bond Price = 1115.46

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

MV of equity=49*3000000

=147000000

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

MV of Bond=1000*270000*1.11546

=301174200

MV of firm = MV of Equity + MV of Bond

=147000000+301174200

=448174200

Weight of equity = MV of Equity/MV of firm

Weight of equity = 147000000/448174200

W(E)=0.328

Weight of debt = MV of Bond/MV of firm

Weight of debt = 301174200/448174200

W(D)=0.672

Cost of equity

As per CAPM

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

Cost of equity% = 4.8 + 1.4 * (5.6)

Cost of equity% = 12.64

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

After tax cost of debt = 7*(1-0.31)

= 4.83

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

WACC=4.83*0.672+12.64*0.328

WACC =7.39%