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The Summit Corporation has the following information. Debt: 30,000 bonds outstanding, 6 percent coupon, $1,000 par...

The Summit Corporation has the following information. Debt: 30,000 bonds outstanding, 6 percent coupon, $1,000 par value, 10 years to maturity, selling for 98 percent of par; the bonds make semiannual coupon payments. Common stock: 300,000 shares outstanding, selling for $30 per share; the beta is 1.60. The company s tax rate is 25 percent. The market risk premium is 7.0 percent and the risk-free rate is 4.0 percent. Find the company's WACC.

Expert Solution

Debt:

Number of bonds outstanding = 30,000
Face Value = $1,000

Current Price = 98% * $1,000
Current Price = $980

Market Value of Debt = 30,000 * $980
Market Value of Debt = $29,400,000

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

Time to Maturity = 10 years
Semiannual Period to Maturity = 20

Let Semiannual YTM be i%

$980 = $30 * PVIFA(i%, 20) + $1,000 * PVIF(i%, 20)

Using financial calculator:
N = 20
PV = -980
PMT = 30
FV = 1000

I = 3.136%

Semiannual YTM = 3.136%
Annual YTM = 2 * 3.136%
Annual YTM = 6.272%

Before-tax Cost of Debt = 6.272%
After-tax Cost of Debt = 6.272% * (1 - 0.25)
After-tax Cost of Debt = 4.704%

Common Stock:

Number of shares outstanding = 300,000
Current Price = $30

Market Value of Common Stock = 300,000 * $30
Market Value of Common Stock = $9,000,000

Cost of Common Stock = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Stock = 4.00% + 1.60 * 7.00%
Cost of Common Stock = 15.20%

Market Value of Firm = Market Value of Debt + Market Value of Common Stock
Market Value of Firm = $29,400,000 + $9,000,000
Market Value of Firm = $38,400,000

Weight of Debt = $29,400,000 / $38,400,000
Weight of Debt = 0.765625

Weight of Common Stock = $9,000,000 / $38,400,000
Weight of Common Stock = 0.234375

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Common Stock * Cost of Common Stock
WACC = 0.765625 * 4.704% + 0.234375 * 15.200%
WACC = 7.16%

jeff jeffy answered 1 year ago

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