A company has $119 million in outstanding bonds, and 10 million shares of stock currently trading...

A company has $119 million in outstanding bonds, and 10 million shares of stock currently trading at $39 per share.The bonds pay an annual coupon rate of 6% and is trading at par. The company's beta is 0.9, its tax rate is 40%, the risk-free rate is 4%, and the market risk premium is 5%. What is this firm's WACC?

Expert Solution

7.37%

Step-1:Calculate weight of each component of capital
								Million
Value of bond							=	$ 119
Value of stock		=	10	Million	x	$ 39	=	$ 390

Total								$ 509

Weight of :
Bond	=	$ 119	/	$ 509	=	23%
Stock	=	$ 390	/	$ 509	=	77%

Step-2:Calculate cost of each component of capital

Since bond is trading at par .it means bond's yield and coupon is similar.

So, before tax bond's yield			=	6%
After tax bond's yield			=	Before tax bonds yield*(1-Tax Rate)
			=	6%*(1-0.40)
			=	3.60%

Cost of equity (Stock)					=	Risk Free +Beta*Market risk premium
(as per Capital Asset pricing moel (CAPM))					=	4%+0.9*5%
					=	8.5%


Step-3:Calculate WACC

WACC	=	(After tax cost of debtWeight of debt)+(Cost of equityWeight of Equity)
	=	(3.60%23%)+(8.5%77%)
	=	7.37%

jeff jeffy answered 2 years ago

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