Question

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?

Answer 1

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 debt*Weight of debt)+(Cost of equity*Weight of Equity)
	=	(3.60%*23%)+(8.5%*77%)
	=	7.37%