Question

In: Finance

Jack's Construction Co. has 80 bonds outstanding that are selling at their par value of $1,000 ea...

Jack's Construction Co. has 80 bonds outstanding that are selling at their par value of $1,000 each. Bonds with similar characteristics are yielding a pretax 8.6 percent. The firm also has 4,000 shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. T-bill is yielding 4 percent, the market risk premium is 8 percent, and the firm's tax rate is 21 percent. What is the firm's weighted average cost of capital assuming its earnings are sufficient to classify all interest as a tax-deductible expense? What does this WACC mean?

Solutions

Expert Solution

Market Value of Debt and Equity

Market Value of Debt = $80,000 [80 Bonds x $1,000 per bond]

Market Value of Equity = $160,000 [4,000 Shares x $40 per share]

Total Market Value = $240,000 [$80,000 + $160,000]

Weight of Capital Structure

Weight of Debt = 0.3333 [$80,000 / $240,000]

Weight of Equity = 0.6667 [$160,000 / $240,000]

After Tax Cost of Debt

After Tax Cost of Debt = Pre-tax Yield to maturity x (1 – Tax Rate)

= 8.60% x (1 – 0.21)

= 8.60% x 0.79

= 6.79%

Cost of Equity

Cost of Equity = Risk-free Rate + (Beta x Market Risk Premium)

= 4.00% + (1.10 x 8.00%)

= 4.00% + 8.80%

= 12.80%

Therefore, the Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]

= (6.79% x 0.3333) + (12.80% x 0.6667)

= 2.27% + 8.53%

= 10.80%

“Hence, the firm's weighted average cost of capital would be 10.80%”


Related Solutions

Jack's construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar...
Jack's construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.5%. The company alson has 4 million shares of common stock outstanding. the stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4% and the market risk premium is 8%. Jack's tax rate is 35%. What is Jack's weighted average cost of capital?
Jacks Construction has 80 bonds outstanding that are selling at their par value of $1000 each....
Jacks Construction has 80 bonds outstanding that are selling at their par value of $1000 each. Bonds with similar characteristics are yielding a pre-tax 8.6% ( pre-tax cost of debt). The firm has 4000 shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The US T-bill is yielding 4%, the market risk premium is 8% and the firms tax rate is 21%. The firm is considering a 5 year expansion project...
Parole Co. has 72,158 bonds outstanding that are selling at par value. The bonds yield 8.8...
Parole Co. has 72,158 bonds outstanding that are selling at par value. The bonds yield 8.8 percent. The company also has 4.7 million shares of common stock outstanding. The stock has a beta of 1.3 and sells for $46.8 a share. The U.S. Treasury bill is yielding 3.8 percent and the market risk premium is 7.8 percent. Parole's tax rate is 30 percent. What is the firm's weighted average cost of capital? Enter answer in percents. Use Excel and show...
Parole Co. has 77,910 bonds outstanding that are selling at par value. The bonds yield 8.5...
Parole Co. has 77,910 bonds outstanding that are selling at par value. The bonds yield 8.5 percent. The company also has 5.4 million shares of common stock outstanding. The stock has a beta of 1.2 and sells for $46.3 a share. The U.S. Treasury bill is yielding 3.5 percent and the market risk premium is 8.3 percent. Parole's tax rate is 32 percent. What is the firm's weighted average cost of capital? Enter answer in percents.
The white sands company has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par;...
The white sands company has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5 years until final maturity; and a 9 percent coupon rate (with interest paid semiannually). Interestingly, American Express has a very similar bond issue outstanding. In fact, every bond feature is the same as for the white sands bonds, except that American express bonds mature in exactly 10 year. Now, assume that the market’s nominal annual required rate of return for both bond issues...
Q1/BlockOut Co. has 76,061 bonds outstanding that are selling at par value. The bonds yield 8.5...
Q1/BlockOut Co. has 76,061 bonds outstanding that are selling at par value. The bonds yield 8.5 percent. The company also has 4.1 million shares of common stock outstanding. The stock has a beta of 1.35 and sells for $46.2 a share. The U.S. Treasury bill is yielding 4.6 percent and the market risk premium is 7.2 percent. Blackout's tax rate is 34 percent. What is the firm's weighted average cost of capital? (Enter answer in percents.) Q2/Dominosa, Inc. wants to...
Jack’s Construction Co. has 80,000 bonds outstanding with annual coupon rate of 8.5% selling at par...
Jack’s Construction Co. has 80,000 bonds outstanding with annual coupon rate of 8.5% selling at par value. The bonds have 10 years to maturity. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The risk free rate 4 percent and the market risk premium is 8 percent. Jack’s tax rate is 35 percent. What is Jack’s weighted average cost of capital?
Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5...
Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5 years until final maturity; and a 9 percent coupon rate (with interest paid semiannually). Interestingly, Old Chicago Brewery has a very similar bond issue outstanding. In fact, every bond feature is the same as for the Red Frog bonds, except that Old Chicago’s bonds mature in exactly 15 years. Now, assume that the market’s nominal annual required rate of return for both bond issues...
Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5...
Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5 years until final maturity; and a 9 percent coupon rate (with interest paid semiannually). Interestingly, Old Chicago Brewery has a very similar bond issue outstanding. In fact, every bond feature is the same as for the Red Frog bonds, except that Old Chicago’s bonds mature in exactly 15 years. Now, assume that the market’s nominal annual required rate of return for both bond issues...
Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5...
Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5 years until final maturity; and a 9 percent coupon rate (with interest paid semiannually). Interestingly, Old Chicago Brewery has a very similar bond issue outstanding. In fact, every bond feature is the same as for the Red Frog bonds, except that Old Chicago’s bonds mature in exactly 15 years. Now, assume that the market’s nominal annual required rate of return for both bond issues...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT