Question

Easy Car Corp. is a grocery store located in the Southwest. It paid an annual dividend of ​$4.00 last year to its shareholders and plans to increase the dividend annually at the rate of 5.0​%. It currently has 2,000,000 common shares outstanding. The shares currently sell for ​$11 each. Five years ago, Easy Car Corp. issued 10,000 semiannual 21-year bonds with a coupon rate of 8​% and a par value of ​$1,000. The bonds currently have a yield to maturity​ (YTM) of 10%. What is the weighted average cost of capital (WACC) for Easy Car Corp. if the corporate tax rate is 20%?

Answer 1

Answer:

Equity:

Last Dividend, D0 = $4
Growth Rate, g = 5.0%
Current Price, P0 = $11

D1 = D0 * (1+ g)
D1 = $4 * (1 + 0.05)
D1= $4.2

Cost of Equity = D1 / P0 + g
Cost of Equity = $4.20 / $11 + 0.05
Cost of Equity = 43.18%

Market Value of Equity = Number of Shares * Market Price per share
Market Value of Equity = 2,000,000* $11
Market Value of Equity = $22,000,000

Debt:

Par Value = $1,000

Annual Coupon Rate = 8.00%
Semiannual Coupon Rate = 4.00%
Semiannual Coupon = 4.00% * $1,000
Semiannual Coupon = $40

Time to Maturity = 16 years
Semiannual Period = 32

Annual YTM = 10.00%
Semiannual YTM = 5.00%

Current Price = $40 * PVIFA(5.00%, 32) + $1,000 * PVIF(5.00%, 32)
Current Price = $40 * (1 - (1/1.05)^32) / 0.05 + $1,000 / 1.05^32
Current Price = $841.97

Market Value of Debt = Number of Bonds * Current Price
Market Value of Debt = 10,000 * $841.97
Market Value of Debt = $8,419,700

Cost of Debt = Yield to Maturity
Cost of Debt = 10.00%

After Cost of Debt = Before Cost of Debt * (1 – tax rate)
After cost of Debt = 10.00% * (1-0.20)
After Cost of Debt = 8%

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $8,419,700 + $22,000,000
Market Value of Firm = $30,419,700

Weight of debt = $8,419,700 / $30,419,700
Weight of Debt = 0.2768

Weight of Equity = $22,000,000 / $30,419,700
Weight of Equity = 0.7232

WACC = Weight of Debt * After cost of Debt + Weight of Equity * Cost of Equity
WACC = 0.2768 * 8% + 0.7232 *43.18%
WACC = 33.44%