Question

Cowbell Corp. is a manufacturer of musical instruments. There are 51 million shares, each selling at $80 / share with an equity beta of 1.14. The risk-free rate is 5% and the market risk premium is 9%. There is $1.00 billion in outstanding debt (face value), paying a 9% s/a coupon for 15 years, which is currently quoted at 110% of par. Assuming a 40% tax rate, what is Cowbell Corp.’s WACC?

Answer 1

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

MV of equity=80*51000000

=4080000000

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

MV of Bond=1000*1000000*1.1

=1100000000

MV of firm = MV of Equity + MV of Bond

=4080000000+1100000000

=5180000000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 4080000000/5180000000

W(E)=0.7876

Weight of debt = MV of Bond/MV of firm

Weight of debt = 1100000000/5180000000

W(D)=0.2124

Cost of equity

As per CAPM

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

Cost of equity% = 5 + 1.14 * (9)

Cost of equity% = 15.26

Cost of debt

K = N

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

k=1

K =15

1100 =∑ [(9*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^15

k=1

YTM = 7.842888209

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

After tax cost of debt = 7.842888209*(1-0.4)

= 4.7057329254

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

WACC=4.71*0.2124+15.26*0.7876

WACC =13.02%