Question

Bob Company has 46 million shares outstanding trading for $11 per share. Bob Co also has $97 million in outstanding debt. Suppose​ Bob Co equity cost of capital is 17%​, its debt cost of capital is 9%​, and a corporate tax rate is 30%.

a. What is​ Bob Co's unlevered cost of​ capital?

b. What is​ Bob Co's after-tax debt cost of​ capital?

c. What is​ Bob Co's weighted average cost of​ capital?

Answer 1

- Total Market value of equity = No of shares outstanding*market price

Total Market value of equity = 46 million*$11

Total Market value of equity = $506 million

- Total Market Value of Bond = $97 million

Total Capital Structure = Total Market Value of Bond + Total Market value of equity

Total Capital Structure = $506 million + $97 million

Total Capital Structure = $603 million

a). Calculating Bob Co's unlevered cost of​ capital which is equal to pre-tax WACC:-

Pre-Tax WACC = (Weight of Debt)(Cost of Debt)+ (Weight of Equity)(Cost of Equity)

Pre-Tax WACC = ($97M/$603M)(9%) + ($506M/$603M)(17%)

Pre-Tax WACC = 1.4478% + 14.2653%

Pre-Tax WACC = 15.71%

So, Bob Co's unlevered cost of​ capital is 15.71%

b). After-Tax Cost of Debt = Cost of debt*(1- Tax rate)

After-Tax Cost of Debt = 9%*(1-0.30)

After-Tax Cost of Debt = 6.3%

c). Calculating Bob Co's weighted average cost of​ capital(WACC):-

WACC = (Weight of Debt)(After-Tax Cost of Debt)+ (Weight of Equity)(Cost of Equity)

WACC = ($97M/$603M)(6.3%) + ($506M/$603M)(17%)

WACC = 1.0134% + 14.2653%

WACC = 15.28%

So, Bob Co's weighted average cost of​ capital is 15.28%

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