Question

Given the information provided here, what is this firm's WACC?

• coupon rate on company bonds = 4.0%
• years until maturity on the bonds = 16
• current price of company bonds = $813.98
• recent stock price = $29.10
• dividend expected at the end of the next period = $1.60
• annual growth rate of dividend = 3.50%
• average effective tax rate over past five years = 30%
• total long-term debt = $650 million
• total shareholders' equity = $350 million
• no preferred stock

Answer 1

Firstly, we will calculate the cost of debt with the available information on the bonds issued by the company.

Future value= $1,000

Time= 16 years

Coupon payments= 4% 0.04*1,000= $40

Present value= $813.98

The yield to maturity of the bonds is calculated by entering the below in a financial calculator:

FV= 1,000; N= 16; PMT= 40; PV= 813.98

Press CPT and I/Y to obtain the yield

The yield on the bonds is 5.82%.

The cost of equity is calculated using the dividend discount model.

It is calculated using the below formula:

Ke=D1/Po+g

Where:

D1= Next year’s dividend

Po=Current stock price

g=Firm’s growth rate

Ke= $1.60/$29.20 + 0.035

     = 0.0548 + 0.035

     = 0.0898 8.98%.

The firm’s long term debt= $650 million

The firm’s equity= $350 million

Total capital of the firm= $650 + $350= $1,000 million

Percentage of debt in the capital structure= $650/ $1,000= 0.65 65%

Percentage of equity in the capital structure= $350/ $1,000= 0.35 35%

Weighted Average Cost of Capital (WACC) is calculated by using the formula below:

WACC= wd*kd(1-t)+we*ke

Where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

WACC= 0.65* 5.82%(1-0.30) + 0.35*8.98%

            = 0.65* 4.07% + 0.35*8.98%

            = 2.65 + 3.14 = 5.79%.