Question

A company has $105 million in outstanding bonds, and 10 million shares of stock currently trading at $36 per share.The bonds pay an annual coupon rate of 9% and is trading at par. The company's beta is 0.8, its tax rate is 40%, the risk-free rate is 2%, and the market risk premium is 6%. What is this firm's WACC?

Answer 1

Given,
Value of bonds outstanding	$105 million	(trading at par)
Number of shares outstanding	10 million
Price per share	$36
Coupon rate of bond	9%
Beta	0.8
Tax rate	40%
Risk free rate (Rf)	2%
Market risk premium (Rm-Rf)	6%
Calculation of weights
Value of equity= Number of shares outstanding*Price per share
	10 million*$36
	$360 millions
Total of debt and equity= $(105+360) millions
	$465 millions
Weight of debt (Wd)= 105/465
	0.23	(rounded off to two decimal places)
Weight of equity= 360/465
	0.77	(rounded off to two decimal places)
Calculation of costs
Cost of debt (Kd)= Coupon rate*(1-tax rate)
	9*(1-0.4)
	5.40%
Cost of equity (Ke)= Rf+(Rm-Rf)*Beta
	2+6*0.8
	6.80%
WACC= Weighted average	(Wd*Kd)+(We*Ke)
	(0.23*5.40)+(0.77*6.80)
	6.478%