Question

Given the following information for Kose, Inc, find the WACC. Assume the company’s tax rate is 35%. Debt: 10,000 9% coupon bonds outstanding, $1,000 par value, 25 years to maturity, currently selling for 100% of par, and the bonds make annual payments. Common stock: 200,000 shares outstanding, selling for $60 per share; the beta is 1.15. Market: 7% market risk premium and 3% risk-free rate.

Answer 1

As per CAPM,

Required Return = Risk Free rate + (Market Return - Risk Free Rate ) * Beta

= Risk Free rate + (Market Risk Premium ) * Beta

= 3% + ( 7% * 1.15)

= 11.05%

The Approximate Yield to Maturity Formula =[Coupon + ( Face Value - Market Price) / Number of years to maturity] / [( Face Value + Market Price)/2 ] *100

= [$ 90+ ( $ 1,000- $1,000 ) / 25] /[( $ 1,000+ $ 1000 )/2] *100

= 90/ 1000*100

= 9%

Note : Coupon = Rate * Face Value

= 9% * $ 1,000

= $ 90

Since this formula gives an approximate value, the financial calculators can be used alternatively.

where,

Par Value = $ 1,000

Market Price = $ 1000

Annual rate = 9% and

Maturity in Years = 25 Years

Hence the yield to maturity = 9.00%

After Tax Cost of Debt = yield to maturity * ( 1- tax Rate)

= 9% * ( 1- 35%)

=5.85%

Value of Debt = 10,000 * $ 1,000

= $ 10,000,000

Value of Equity = 200,000 Shares * $ 60

= $ 12,000,000

Total Value = $ 22,000,000

Weight of Debt = ( 10,000,000 / 22,000,000)

Weight of Equity = ( 12,000,000 / 22,000,000)

WACC = Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity

= 5.85% * ( 10,000,000 / 22,000,000)+ 11.05% * ( 12,000,000 / 22,000,000)

= 8.69%

Hence the correct answer is 8.69%