Question

A corporation has 10,000 bonds outstanding with a 7% annual coupon rate, 10 years to maturity, a $1,000 face value, and a $950 market price. The company’s 400,000 shares of common stock sell for $85 per share, have a beta of 1.2, the risk-free rate is 2%, and the expected market return is 18%. Assuming a tax rate of 35%, what is this corporation’s weighted average cost of capital?

Please use excel and show the formulas used if can. Thanks in advance.

Answer 1

Where, E = Equity, D = Debt, Re = cost of equity, Rd = cost of debt , T = tax rate

Total market value of debt = no. of bonds * market value of bonds = 10,000 * 950 = 9,500,000

Total market value of equity = No of shares * price per share = 400,000 * 85 = 34,000,000

E/(E+D) = 34,000,000 /( 34,000,000+9,500,000) = 0.78

D/(E+D) = 1- 0.78 = 0.22

Re = Risk free rate + beta * (expected market return - risk free rate) ----using CAPM model

Re = 2% + 1.2 * (18%-2%) = 21.20%

Rd = annual copuon rate = 7%

T = 35%

so WACC = 0.78 * 21.20% + 0.22 * 7% * (1-0.35) = 17.56%

No of bonds	10,000
Coupon rate	7%
Face value	1000
Market price	950
Debt (D )	95,00,000
No of shares	400000
Price per share	85
Equity (E )	3,40,00,000
E/(E+D)	0.78
D/(E+D)	0.22
Risk free rate	2%
beta	1.2
market return	18%
Re	21.20%
WACC	17.56%