Question

ABC Corp. issued 5,000 par value bonds today with 30 years to maturity. The coupon rate is 6% and coupons are paid semiannually. The current price of each bond is $890.00. In addition, there are 1,000,000 shares of common stock outstanding with a market price of $22 per share. ABC Corp.’s beta is 1.20, the market risk premium is 10% and the risk free rate is 3%. Assume a tax rate of 30%. Calculate the WACC for ABC Corp.

Answer 1

WACC=(weight of common stock*cost of equity)+(Weight of debt*after tax cost of debt)

Market value of the debt= Number of bonds*price of each bond=5000*$890=$4,450,000

Market value of the common stcok=Number of shares*market price per share=1000000*22=$22,000,000

Total value=$4450000+$22000000=$26450000

Weight of debt=Market value of debt/Total value=$4450000/$26450000=16.82%

Weight of common stock=Market value of common stock/Total value=$22000000/$26450000=83.18%

Cost of equity=risk free rate+(beta*market risk premium)=3%+(1.2*10%)=15%

Before tax cost of debt can be found using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

The bond payments are semi-annual

nper=30*2=60

pmt=semi-annual coupon payment=(6%*1000)/2=30

pv=890

fv=1000

=RATE(60,30,-890,1000,0)=3.44%

RATE=semi-annual yield=3.44%

Annual yield=before tax cost of debt=2*3.44%=6.87%

After tax cost of debt=before tax cost of debt*(1-tax rate)=6.87%*(1-30%)=4.81%

WACC=(83.18%*15%)+(16.82%*4.81%)=13.29%