Question

Easy Car Corp. is a grocery store located in the Southwest. It paid an annual dividend of ​$3.00 last 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 ​$17 each. Two years ago, Easy Car Corp. issued 40,000 semiannual 28-year bonds with a coupon rate of 9​% and a par value of ​$1,000. The bonds currently have a yield to maturity​ (YTM) of 13%. What is the weighted average cost of capital (WACC) for Easy Car Corp. if the corporate tax rate is 30%?

Answer 1

Equity:

Last Dividend, D0 = $3
Growth Rate, g = 3.0%
Current Price, P0 = $17

D1 = D0 * (1+ g)
D1 = $3 * (1 + 0.03)
D1= $3.09

Cost of Equity = D1 / P0 + g
Cost of Equity = $3.09 / $17 + 0.03
Cost of Equity = 0.2118 or 21.18%

Market Value of Equity = Number of Shares * Market Price per share
Market Value of Equity = 1,000,000* $17
Market Value of Equity = 17,000,000

Debt:

Par Value = $1,000

Annual Coupon Rate = 9.00%
Semiannual Coupon Rate = 4.50%
Semiannual Coupon = 4.50% * $1,000
Semiannual Coupon = $45

Time to Maturity = 26 years
Semiannual Period = 52

Annual YTM = 13.00%
Semiannual YTM = 6.50%

Current Price = $45 * PVIFA(6.50%, 52) + $1,000 * PVIF(6.50%, 52)
Current Price = $45 * (1 - (1/1.065)^52) / 0.065 + $1,000 / 1.065^52
Current Price = $703.95

Market Value of Debt = Number of Bonds * Current Price
Market Value of Debt = 40,000 * $703.95
Market Value of Debt = $28,158,000

Cost of Debt = Yield to Maturity
Cost of Debt = 13.00%

After Cost of Debt = Before Cost of Debt * (1 – tax rate)
After cost of Debt = 13.00% * (1-0.30)
After Cost of Debt = 9.1%

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $28,158,000 + $17,000,000
Market Value of Firm = $45,158,000

Weight of debt = $28,158,000 / $45,158,000
Weight of Debt = 0.6235

Weight of Equity = $17,000,000 / 45,158,000
Weight of Equity = 0.3765

WACC = Weight of Debt * After cost of Debt + Weight of Equity * Cost of Equity
WACC = 0.6235 * 9.1% + 0.3765 *21.18%
WACC = 13.65%