Question

1. The total book value of WTC’s equity is $13 million, and book value per share is $20. The stock has a market-to-book ratio of 1.5, and the cost of equity is 9%. The firm’s bonds have a face value of $9 million and sell at a price of 110% of face value. The yield to maturity on the bonds is 6%, and the firm’s tax rate is 40%. What is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) WACC=

2. Micro Spinoffs Inc. issued 20-year debt a year ago at par value with a coupon rate of 5%, paid annually. Today, the debt is selling at $1,140. If the firm’s tax bracket is 35%, what is its percentage cost of debt? Assume a face value of $1,000. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

3. Pangbourne Whitchurch has preferred stock outstanding. The stock pays a dividend of $12 per share, and sells for $80. The corporate tax rate is 35%. What is the percentage cost of the preferred stock? (Enter your answer as a whole percent.) Cost of preferred stock =

4. Reactive Power Generation has the following capital structure. Its corporate tax rate is 40%.

Security	Market Value			Required Rate of Return
Debt	$	30	million		4	%
Preferred stock		30	million		6
Common stock		40	million		10

What is its WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

1. WACC =

where, E = Market value of equity

D = Market value of debt

Re = Cost of equity

Rd = Pre-tax cost of debt

t = tax rate

Here,

Book value of a share = $20

Market value of a share = 1.5 x $20 = $30

Book value of shares = $13m

Number of shares = 13m / 20 = 650,000

Market value of shares = $30 x 650,000 = $1,950,000 = E

Re = 9%

Book value of debt = $9,000,000

Market value of debt = 110% x $9,000,000 = $9,900,000 = D

Rd = 6%

t = 40%

Hence, WACC = (1950000/(1950000 + 9900000)) x 9% + (9900000/(1950000 + 9900000) x 6% x (1-40%) = 6.78%

2. Cost of debt = Coupon rate x (1 - tax rate) = 5% x (1 - 35%) = 3.25%

(Irrespective of what the debt is selling at)

3. % cost of preferred stock = 12 / 80 = 15% (as dividends on preferred stock are not tax deductible

4. Using the same forumla as part 1, and extending it to preferred stock:

WACC =

where P = market value of preferred stock

Rp = Rate of return on preferred stock,

WACC = 6.52%