Question

Given the following information for Silicon Tech, find its WACC. Assume the company s tax rate is 25 percent. Debt: 30,000, 5.5 percent coupon bonds outstanding, $1,000 par value, 10 years to maturity, selling for 98 percent of par; the bonds make semiannual coupon payments. Common stock: 400,000 shares outstanding, selling for $40 per share; the beta is 1.60. Market: 7.0 percent market risk premium and 4.5 percent risk-free rate.

Answer 1

Equity:

Market Risk Premium = 7%, Risk-Free Rate = 4.5% and Beta = 1.6

Cost of Equity = Risk_Free Rate + Beta x Market Risk Premium = 4.5 + 7 x 1.6 = 15.7 %

Price per Share = $ 40 and Number of Shares Outstanding = 400000

Equity Value = 400000 x 40 = E = $16000000

Debt:

Number of Bonds Outstanding = 30000, Coupon Rate = 5.5 % payable semi-annually, Par Value = $ 1000, Tenure = 10 years or 20 half-years, Current Market Price = 98% of Par Value or (0.98 x1000) = $ 980

Let the semi-annual yield be r

Semi-Annual Coupon Payment = 0.055 x 1000 x 0.5 = $ 275

Therefore, 980 = 27.5 x (1/r) x [1-{1/(1+r)^(20)}] + 1000/(1+r)^(20)

Using hit and trial method/EXCEL's Goal Seek Function to solve the above equation we get:

r = 0.02883 or 2.883 %

Yield to Maturity = 2 x r = 2 x 2.883 = 5.766 %

Cost of Debt = 5.766 %

Debt Value = D = 30000 x 980 = $ 29400000

Total Firm Value = V =16000000+29400000 = $ 45400000

Debt Proportion = (D/V) = (29400000 / 45400000) = 0.6476 and Equity Proportion = (16000000/45400000) = 0.3524

Tax Rate = 25 %

Weighted Average Cost of Capital = Cost of Debt x Debt Proportion x (1-Tax Rate) + Cost of Equity x Equity Proportion = 5.766 x 0.6476 x (1-0.25) + 15.7 x 0.3524 = 8.33 %