Question

Suppose a firm has 29.90 million shares of common stock outstanding at a price of $11.61 per share. The firm also has 103000.00 bonds outstanding with a current price of $1,087.00. The outstanding bonds have yield to maturity 8.75%. The firm's common stock beta is 1.504 and the corporate tax rate is 38.00%. The expected market return is 13.80% and the T-bill rate is 5.97%. Compute the following:

a) Weight of Equity of the firm

b) Weight of Debt of the firm

c) Cost of Equity of the firm

d) After Tax Cost of Debt of the firm

e) WACC for the Firm

Answer 1

Market value of common stock = $29,900,000 * $11.61 = $347,139,000

Market value of bonds = 103,000 * $1,087 = $111,961,000

Total Market value = Market value of common stock + Market value of bonds

= $347,139,000 + $111,961,000

= $459,100,000

Question a:

Weight of Equity of firm = Market value of common stock / Total Market value

= $347,139,000 / $459,100,000

= 0.7561

Question b:

Weight of Debt of firm = Market value of common stock / Total Market value

= $111,961,000 / $459,100,000

= 0.2439

Question c:

Stock beta = 1.504

Risk free rate = Rf = T bill rate = 3.94%

Expected Market Return = Rm = 13.8%

Cost of Equity = Rf + Beta * (Rm-Rf)

= 3.94% + 1.504 * (13.8%-3.94%)

= 3.94% + 14.82944%

= 18.76944%

Therefore, Cost of Equity is 18.77%

Question d:

Cost of Debt = 8.75%

tax rate = t = 38%

After tax cost of debt = Cost of debt * (1 - tax rate) = 8.75% * (1-38%) = 5.425%

Question e:

WACC for the firm = [Weight of debt * after tax cost of debt] + [Weight of equity * Cost of equity]

= [0.2439 * 5.425%] + [0.7561 * 18.77%]

= 1.3232% + 14.120%

= 15.5152%

WACC for the firm is 15.52%