Question
In: Finance
An analyst is trying to determine the capital structure for Big Dawg Incorporated. After some careful...
An analyst is trying to determine the capital structure for Big Dawg Incorporated. After some careful research, the analyst knows the following:
--Big Dawg has 1.94 million shares of common stock trading today at $19.13 per share. The book value of Big Dawg common stock is $15.00 million. The cost of equity for the firm is estimated to be 16.00%.
--Big Dawg has $9.00 million in long-term debt on its balance sheet. The debt is trading at 92.00% of face value in the market with a yield to maturity of 9.00%. The tax rate facing the firm is 36.00%.
What is the WACC for Big Dawg Incorporated?
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Answer format: Percentage Round to: 2 decimal places (Example: 9.24%, % sign required. Will accept decimal format rounded to 4 decimal places (ex: 0.0924))
Solutions
Expert Solution
Here we need to consider market value of equity rather than book value as the market value is a better representation of worth for the purpose of calculation of WACC. For debt, note that yield to maturity is calculated as per the market price already so we take the book value of debt that is $9 million.
Below are all the calculations:
| Market value of equity | 37112200 | Cost of equity (Re) | 16% | |||||
| Value of debt | 9000000 | Cost of debt (Rd) | 9% | |||||
| After tax cost of debt (Rd(1-T)) | =9% * ( 1 - 36%) | |||||||
| 5.76% | ||||||||
| Total market value | 46112200 | |||||||
| Weight of equity (We = Equity / total value) | 80.48% | |||||||
| Weight of debt (Wd = Debt value / total value) | 19.52% | |||||||
| WACC = | We * Re + Wd * Rd*(1-Tax rate) | |||||||
| = 80.48% * 16% + 19.52% * 5.76% | ||||||||
| 14.00% | ||||||||
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