Question

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 have a weighted average cost of capital of 8.2 percent. The firm has an aftertax cost of debt of 5.2 percent and a cost of equity of 11.6 percent. What debt ratio is needed for the firm to achieve their targeted weighted average cost of capital? Enter the answer in percents.

Answer 1

Part 1) D = Debt_marketValue = number of qty * price of bond = 76061 * $1000 = $70,606,100

{***assuming par value of the bond is $1000 since not mentioned explicitly, price of bond in this case is par value}

E = Equity_marketValue = number of qty * price per share = 4100000 * $46.2 = $189,420,000

TC = Total Capital = Debt_marketValue + Equity_marketValue = D + E = $70,606,100 + $189,420,000

=$260,026,100

t = tax rate = 34%

r_d = bonds yield = 8.5%

r_e = Rf + Beta * (Risk Premium) = 4.6% + 1.35 * 7.2% = 14.32% {using CAPM}

WACC = D/(TC) * r_d * (1-t) + E/(TC) * r_e = 70,606,100/260,026,100 * 8.5% +  189,420,000/260,026,100 * 14.32%

WACC_BlockOutCo= 12.7397% (rounded to 4 decimals)

Part 2)

WACC = D/(TC) * r_{d_afterTax} + [1 - D/(TC)] * r_e ...(1)

given WACC = 8.2%, r_{d_afterTax} = 5.2%, r_e=11.6% ...(2)

From (1) & (2),

8.2% = D/(TC) * 5.2% + [1 - D/(TC)] * 11.6%

8.2% = D/(TC) * 5.2% + 11.6% - [11.6% * D/(TC)]

-D/(TC) * 5.2% + 11.6% * D/(TC) = 11.6% - 8.2% {taking unknown terms on one side}

6.4% * D/(TC) = 3.4%

D/(TC) = 0.034/0.064

D/(TC) = 17/32 = 0.53125 = 53.125%