Question

In: Finance

A company has $105 million in outstanding bonds, and 10 million shares of stock currently trading...

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?

Solutions

Expert Solution

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%

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