Question

QUESTION 41 The current stock price for a company is $48 per share, and there are 4 million shares outstanding. The beta for this firms stock is 1.3, the risk-free rate is 4.7, and the expected market risk premium is 6.4%. This firm also has 230,000 bonds outstanding, which pay interest semiannually. These bonds have a coupon interest rate of 7%, 17 years to maturity, a face value of $1,000, and an annual yield to maturity of 7.1%. 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

K = Nx2

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

k=1

K =17x2

Bond Price =∑ [(7*1000/200)/(1 + 7.1/200)^k]     +   1000/(1 + 7.1/200)^17x2

k=1

Bond Price = 990.22

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

MV of equity=48*4000000

=192000000

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

MV of Bond=1000*230000*0.99022

=227750600

MV of firm = MV of Equity + MV of Bond

=192000000+227750600

=419750600

Weight of equity = MV of Equity/MV of firm

Weight of equity = 192000000/419750600

W(E)=0.4574

Weight of debt = MV of Bond/MV of firm

Weight of debt = 227750600/419750600

W(D)=0.5426

Cost of equity

As per CAPM

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

Cost of equity% = 4.7 + 1.3 * (6.4)

Cost of equity% = 13.02

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

After tax cost of debt = 7.1*(1-0.35)

= 4.615

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

WACC=4.62*0.5426+13.02*0.4574

WACC =8.46%