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The Paulson Company's year-end balance sheet is shown below. Its cost of common equity is 15%,...

The Paulson Company's year-end balance sheet is shown below. Its cost of common equity is 15%, its before-tax cost of debt is 12%, and its marginal tax rate is 25%. Assume that the firm's long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,189. The firm has 576 shares of common stock outstanding that sell for $4.00 per share.

Assets		Liabilities And Equity
Cash	$ 120	Accounts payable and accruals	$ 10
Accounts receivable	240	Short-term debt	59
Inventories	360	Long-term debt	1,130
Plant and equipment, net	2,160	Common equity	1,681
Total assets	$2,880	Total liabilities and equity	$2,880

Calculate Paulson's WACC using market-value weights. Do not round intermediate calculations. Round your answer to two decimal places.

_____%

Expert Solution

WACC refers to the Weighted Average Cost Of Capital of the firm. This is basically the cost of the funds procured by the firm. As capital budgeting decisions are long - term in nature, we only consider long-term funds in the calculation of WACC. WACC basically provides us a minimum rate at which firm's future cash flows can be discounted to bring to the present value. This WACC is basically a return that the suppliers of funds to the firm will require in order to make the funds available for the fiem instead of investing them somewthere else. The fund providers will only invest into the firm if what they are getting is atleast what an investment of equivalent risk will provide them with. If they do not get this minimum rate of return from the firm, they will rather invest their funds elsewhere to get better returns.

WACC is calculated by taking the weights of different sources of funds to the firm and multiplying them by their respective costs and adding up costs so obtained to find out the required rate of return of the firm. WACC can be calculated using both market values and book values.

Here we are required to calculate WACC based on market values of the sources of funds.

Given the question we are provided with information that,

Cost of equity (Ke) = 15% , Cost of debt (Kd) = 12% (before tax)

Company's debt trades in the market at par, so book value and market value is same for debt.

So market value of long-term debt funding = $1,130

Now, market price of equity share = $4

No. of equity shares outstanding =576 , Tax rate = 25%

Market value of equity = No. of shares outstanding * Price per share

= 576 * 4

= $2,304

Total market value of funds = Market value of debt + Market value of equity

= $1,130 + $2,304

= $3,434

Weight of debt in total funds (Wd) = Market value of debt / Total market value of funds

= 1,130 / 3,434

= 0.329

Weight of equity in total funds (We) = Market value of equity / Total market value of funds

= 2,304 / 3,434

= 0.6709

After tax cost of debt = Cost of debt * (1 - tax rate)

= 12% * (1 - 25%)

= 0.12 * (1 - 0.25)

= 0.12 * 0.75

= 0.09

WACC = (Weight of debt * After - tax cost of debt) + (Weight of equity * Cost of equity)

= (0.329 * 0.09) + (0.6709 * 15%)

= 0.02961 + (0.6709 * 0.15)

= 0.02961 + 0.100635

= 0.130245

= 13.02%

Thus the WACC of the firm is 13.02%.

jeff jeffy answered 1 year ago

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