Question

Charlie’s Computer Correction Connection (C4) runs a chain of computer repair franchises. C4’s stock sells for $50 per share and has 1,000,000 shares outstanding. C4 just paid annual dividend of $2 per share and expects the growth rate to be 3% annually. C4 also has 10,000 bonds outstanding, maturing in 8 years with a face value of $1,000 each. The bonds have a 7% coupon rate (make semi-annual coupon payments) and currently sell for $1,000. The tax rate is 30%. What is C4’s weighted-average cost of capital?

Answer 1

Answer = 6.75%

Note:

Market Value of Equity = Price Per Share * Number of Shares

= $ 50 * 1,000,000

= $ 50,000,000

Market Value of Debt = 10,000 Bonds * $ 1,000

= $ 10,000,000

Total Value = $ 50,000,000 + $ 10,000,000

= $ 60,000,000

Price = expected dividend / (required return - growth rate)

50 = (2*103%)/(required return - 3%)

(required return - 3%) = 2.06/50

required return = 7.12%

The Approximate Yield to Maturity Formula =[Coupon + ( Face Value - Market Price) / Number of years to maturity] / [( Face Value + Market Price)/2 ] *100

Since this formula gives an approximate value, the financial calculators can be used alternatively.

where,

Par Value = $ 1,000

Market Price = $  1,000

Annual rate = 7% and

Maturity in Years = 8Years

Hence the yield to maturity =7.00%

Now, the after tax cost of debt = Yield to Maturity * (1- tax Rate)

= 7.00% * ( 1-30%)

= 4.90%

WACC = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

= 6.75%

	Value	Weight ( market value / total)	Cost	Weight *cost
Debt	1,00,00,000.00	0.166666667	4.90%	0.816666667
Equity	5,00,00,000.00	0.833333333	7.12%	5.933333333
Total	6,00,00,000.00			6.75