In: Finance
Hilton Corporation has 1 million shares of common stock outstanding and 80,000 bonds with 6% coupon at $1000 par each. The stock currently sells at $53 per share and has a beta of 1.15; the bonds have 25 years to maturity and sell at $1141. The market risk premium is 6.8% and Treasury bills are yielding 3.1%. If Hilton’s corporate tax rate is 21%, what is the company’s cost of capital (WACC)?
To find the wacc, we need to understand the weight of debt, equity and the cost of each of these types of financing.
Wacc = Cost of equity * Weight of equity + After tax cost of Debt * Weight of debt
Cost of equity:
Using CAPM model, Cost of equity = Risk free rate + Beta * Market risk premium
Risk free rate = T bill rate = 3.1%
Market risk premium = 6.8%
Beta = 1.15
Cost of equity = 3.1% + 1.15 * 6.8% = 10.92%
Total debt = 80000*1000 = 80000000
Total equity = 53*1000000 = 53000000
Weight of equity = (Price of share * No of shares outstanding)/(Debt + equity) = 53000000/(80000000+53000000)= 53000000/133000000 = 39.8 %
Weight of debt =(Face value of bonds * Number of bonds)/(Debt + equity) = 80000000/133000000 = 60.2 %
Cost of debt :
We need to find the yield to maturity for the bonds to find the cost of debt.
Using YTM formula :( (C+F - P)/n)/((F+P)/2)
Face value = F= 1000, Price = P = 1141, Annual coupon= 6% so C = 60, Tenure = n = 25 years
The YTM is 5.005%. Hence after tax cost of debt = YTM ( 1-tax rate) = 5.005*(1-0.21) = 3.95%
Wacc = 10.92% * 39.8% + 3.95% * 60.2% = 6.72%