Question

Market Enterprises, Inc. has 1.0 million shares of stock outstanding. The stock currently sells for $25 per share. The firm’s debt is publicly traded, and its market value was recently quoted at 102% of face value. It has a total face value of $7 million, and it is currently priced to yield 7 percent. The risk-free rate is 6%, and the market risk premium is 7%. You’ve estimated that Market Enterprises has a beta of .95. If the corporate tax rate is 34%, what is the weighted average cost of capital of Market Enterprises, Inc.?

Answer 1

WACC of Market Enterprises Inc.

Market Value of Equity=Outstanding shares*Market Value Of share

Market Value of Equity= 1000000*25

Value of Equity= $25000000

Cost Of Equity= Risk free rate+ Beta*Market Risk Premium

Cost of Equity= 6%+0.95*7%

Cost of Equity= 12.65%

Stocks Outstanding	1000000
Stock price per share	$25
Risk free rate	6%
Market risk premium	7%
Beta	0.95
Value of Equity	$25,000,000
Cost of Equity	12.65%

Market Value Of Debt= Book Value of Debt * 102%

Market Value of Debt= $7000000*102%

Market Value of debt= $7140000

Cost of debt= Interest percent*(1-corporate Tax rate)

Cost of debt= 7%*(1-34%)

Cost of Debt= 4.62%

Book value of Debt	$7,000,000
Market Value of Debt	$7,140,000
Yield on Debt	7%
Corporate Tax rate	34%
Cost of debt	4.6200%

WACC= Equity / (Debt+Equity)*Cost of Equity + Debt / (Debt +Equity)*Cost of Debt

Putting the values in the above formula we get the WACC as 10.87%

Equity/Debt+Equity	0.77784692
Debt/Debt+Equity	0.22215308
WACC	10.87%