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First-Rate Ballroom, Inc., a national convention planner has 2,500 common shares and 1,000 bonds outstanding. Its...

First-Rate Ballroom, Inc., a national convention planner has 2,500 common shares and 1,000 bonds outstanding. Its securities have been performing very well in the marketplace. It enjoys a common stock price of $45 per share, up from $35 a year ago. Its bonds have also performed well, currently priced at $950 per bond, up from $899 a year ago. Its stock has a beta coefficient of 2.5 and a market risk premium of 8.5%. The yield on 30-year Treasury Bonds is 5.5%. First Rate Ballroom's bonds are rather typical for the industry; having 30-year maturities, a 5% coupon rate, and a $1000 face value. What is the WACC of First-Rate Ballroom? First Rate is in the 35% marginal tax rate?
please show work

Solutions

Expert Solution

WACC = (weight of debt * cost of debt) + (weight of common stock * cost of common stock)

market value of debt = bonds outstanding * market price per bond

market value of common stock = shares outstanding * market price per share

weight of debt = market value of debt / total market value

weight of common stock = market value of common stock / total market value

cost of debt = YTM of bond * (1 - tax rate)

YTM is calculated using RATE function in Excel with these inputs :

nper = 30 (30 years to maturity with 1 annual coupon payments each year)

pmt = 1000 * 5% (annual coupon payment = face value * annual coupon rate / 2. This is a positive figure as it is an inflow to the bondholder)

pv = -950 (current bond price. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

cost of debt = YTM * (1 - tax rate)

cost of equity = risk free rate + (beta * market risk premium)

WACC = 5.93%

The calculations are below

jeff jeffy answered 1 year ago
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