Question

Big Bang Solutions, Inc. has $95,600,000 worth of common stock and $57,223,400 worth of coupon bonds. If the required rate of return on the equity is 12.75 percent and the pre-tax yield to maturity on the bonds is 5.5 percent, what is the firm's WACC? The firm's tax rate is 21 percent.

Answer 1

SOLUTION:

The values of Big Bang Solutions, Inc provided in the question are as follows:

Worth of common stock = $95,600,000

Worth of coupon bonds = $57,223,400

Required rate of return on the equity = 12.75 percent

Pre-tax yield to maturity on the bonds = 5.5 percent,

The firm's tax rate = 21 percent. Or 0.21

Firm’s (WACC) Weighted Average cost of capital=?

First of all, we will calculate the after tax cost of debt. So

Calculation of after tax cost of debt

After tax cost of debt = Pre tax cost of Debt * (1- tax)

After tax cost of debt = 5.5 * (1- 0.21)

After tax cost of debt =4.345

CALCULATION OF WEIGHTED AVERAGE COST OF CAPITAL
SOURCE	AMOUNT	WEIGHT	AFTER TAX COST	WEIGHTED COST
A	B	C=A/ $152,823,400	D	E= C*D
COMMON STOCK	$95,600,000	0.6256	12.75	7.9759
COUPON BONDS	$57,223,400	0.3744	4.345	1.6269
TOTAL	$152,823,400	1.0000		9.6028
WEIGHTED AVERAGE COST OF CAPITAL =9.60 %