Question

Easy Car Corp. is a grocery store located in the Southwest. It plans to pay an annual dividend of ​$3.00 next year to its shareholders and plans to increase the dividend annually at the rate of 3.0​%. It currently has 1,000,000 common shares outstanding. The shares currently sell for ​$18 each. Easy Car Corp. also has 10,000 semiannual bonds outstanding with a coupon rate of 6​%, a maturity of 24 ​years, and a par value of ​$1,000. The bonds currently have a yield to maturity​ (YTM) of 14%. What is the weighted average cost of capital (WACC) for Easy Car Corp. if the corporate tax rate is 20%? When answering this problem enter your answer using percentage notation but do not use the % symbol and use two decimals (rounding). For example, if your answer is 0.10469 then enter 10.47; if your answer is 10% then enter 10.00

Answer 1

Answer:
Equity:
Expected Dividend = $3.00
Growth Rate = 3.0%
Current Price = $18

Cost of Equity = Expected Dividend / Current Price + Growth Rate
Cost of Equity = $3.00 / $18 + 0.03
Cost of Equity = 0.1967 or 19.67%

Number of shares outstanding = 1,000,000
Current Price = $18

Market Value of Common Stock = 1,000,000 * $18
Market Value of Common Stock = $18,000,000

Debt:
Before Tax Cost of Debt = 14%
After Tax Cost of Debt = Before Tax Cost of Debt * (1 – Tax Rate)
After Tax Cost of Debt = 14% * (1 – 0.20)
After Tax Cost of Debt = 11.20%

Number of bonds outstanding = 10,000
Par Value = $1,000

Annual Coupon Rate = 6.00%
Semiannual Coupon Rate = 3.00%
Semiannual Coupon = 3.00% * $1,000
Semiannual Coupon = $30

Time to Maturity = 24 years
Semiannual Period = 48

Annual YTM = 14.00%
Semiannual YTM = 7.00%

Current Price = $30 * PVIFA(7.00%, 48) + $1,000 * PVIF(7.00%, 48)
Current Price = $30 * (1 - (1/1.07)^48) / 0.07 + $1,000 * (1/1.07)^48
Current Price = $450.78

Market Value of Debt = 10,000 * $450.78
Market Value of Debt = $4,507,800

Market Value of Firm = Market Value of Equity + Market Value of Debt
Market Value of Firm = $18,000,000 + $4,507,800
Market Value of Firm = $22,507,800

Weight of Equity = $18,000,000 / $22,507,800
Weight of Equity = 0.7997

Weight of Debt = $4,507,800 / $22,507,800
Weight of Debt = 0.2003

WACC = Weight of Common Stock*Cost of Common Stock + Weight of Debt*After-tax Cost of Debt
WACC = (0.7997 * 19.67%) + (0.2003 * 11.20%)
WACC = 17.97