Question

You need to estimate the Weighted Average Cost of Capital (WACC) for your company. You have the following balance sheet data as well as the information provided below Assets Current Assets                                                                                                $38,000,000 Net Plant, Property, and Equipment                                                               101,000,000 Total Assets                                                                                                   $139,000,000 Liabilities and Equity                       Accounts Payable                                                                                           $10,000,000 Accruals                                                                                                          9,000,000 Current Liabilities                                                                                          $19,000,000                Long-term Debt (40,000 bonds, $1,000 face value)                                      $40,000,000 Total Liabilities                                                                                              $59,000,000 Common Stock (10,000,000 shares)                                                              $30,000,000 Retained Earnings                                                                                           50,000,000 Total Shareholder Equity                                                                               $80,000,000                Total Liabilities and Shareholders Equity                                                 $139,000,000 You check The Wall Street Journal and see that your company’s stock is currently selling for $7.50 per share and that its bonds are selling for $889.50 per bond. These bonds have a 7.25% annual coupon rate, with semi-annual payments. The bonds mature in twenty years. Your company’s beta is approximately equal to 1.25. The yield on a 6-month Treasury bill is 3.5% and the yield on a 10-year Treasury bond is 5.5%. The expected return on the stock market is 11.5%, but the stock market has had an average annual return of 10.5% during the past 5 years. Your firm is in the 40% tax bracket. Using the Security Market Line (CAPM ) method, what is the best estimate for the cost of equity?

Answer 1

Sol:

We are required to calculate Weighted average cost of capital :

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