Question

If Wild Widgets, Inc., were an all-equity company, it would have a beta of .90. The company has a target debt-equity ratio of .45. The expected return on the market portfolio is 11 percent and Treasury bills currently yield 2.9 percent. The company has one bond issue outstanding that matures in 20 years, a par value of $1,000, and a coupon rate of 5.9 percent. The bond currently sells for $1,045. The corporate tax rate is 22 percent.

  

a.	What is the company’s cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.	What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c.	What is the company’s weighted average cost of capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

a.Cost of debt % =

b.Cost of equity % =

c.WACC % =

Answer 1

a)

To calculate the company's cost of debt, we have to find the bond's yield to maturity.

The following equation is made use of to find the bond's YTM.

C = Annual coupoun payment = 0.059 $ 1000 = $ 59

r = yield to maturity

M = Par value of the bond

Solving for r in the above equation. The yield to maturity is obtained as 5.52%

The value of r can be obtained using rate function in excel.In excel go to formulas, financial ,select rate function and enter the values as shown.

Company's cost of debt = Yield to maturity

Company's cost of debt = 5.52%

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b)

According to CAPM, the cost of equity is found using the following equation

r_e = r_f + beta ( r_m - r_f )

r_e = 0.029 + 0.90 ( 0.11 - 0.029)

Cost of equity = 10.19%

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c)

WACC = w_e r_e + w_p r_d + w_d r_d ( 1 - tax rate)

The firm has no preference capital, hence w_p r_d = 0

The debt - equity ratio is 0.45 which implies that the firm uses 45% debt and 55% equity.

WACC = 0.55 0.1019 + 0.45 0.0552 ( 1 - 0.22)

WACC = 7.54%

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a.Cost of debt % = 5.52%

b.Cost of equity % = 10.19%

c. WACC % = 7.54%