Question

1. Daves Inc. recently hired you as a consultant to estimate the company’s WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,150.00. (2) The company’s tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock’s beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC? Do not round your intermediate calculations. (Hint: rd will come from the YTM on the bond)

Group of answer choices

8.61%

7.14%

9.90%

9.55%

10.67%

2.

You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained earnings is 10.75%, and the tax rate is 40%. The firm will not be issuing any new stock. What is Quigley's WACC? Round final answer to two decimal places. Do not round your intermediate calculations.

Group of answer choices

9.37%

9.77%

6.77%

7.88%

9.45%

Answer 1

1. WACC=(weight of equity*cost of equity)+(weight of debt*after tax cost of debt)

Cost of debt has to be found using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

nper=20 years

pmt=coupon=coupon rate*face value=8%*1000=80

pv=1150

fv=1000

=RATE(20,80,-1150,1000,0)=6.63%

after tax cost of debt=cost of debt*(1-tax rate)=6.63%*(1-40%)=3.975%

==> cost of equity=risk free rate+(beta*market rsik premium)=4.5%+(1.2*5.5%)=11.1%

WACC=(65%*11.1%)+(35%*3.975%)=8.61%

Option I is correct

2. WACC=(weight of equity*cost of equity)+(weight of debt*after tax cost of debt)+ (weight of preferred stock*cost of preferred stock)

after tax cost of debt=cost of debt*(1-tax rate)=6.5%*(1-40%)=3.90%

WACC=(55%*10.75%)+(35%*3.90%)+(10%*6%)=7.88%

Option IV is correct