Question

In: Accounting

Given the following information, calculate the firm’s WACC. Assume the interest on the debt is 100%...

Given the following information, calculate the firm’s WACC. Assume the interest on the debt is 100% tax deductible. Tax rate: 20% Debt rate: 6% Preferred stock dividend rate: 9% of $100 par value Risk-free rate of return: 2% Market rate of return: 12% Stock beta: 1.3 Debt value: $50,000,000 P/S value: $15,000,000 C/S value: $35,000,000 b) What would a firm use the WACC for?

Solutions

Expert Solution

Working Notes:

1) Cost of Debt (Kd) = Debt Interest Rate * (1 - Tax Rate) = 6% * (1 - 20%) = 4.8%

2) Cost of Preference Share Capital (Kp) = Preference share dividend Percentage = 9%

3) Cost of Equity Share Capital (Ke) = Rf (Return Risk Free) + Beta * [ Rm (return market) - Rf ]

2% + 1.3 * (12% - 2%) = 15 %

4) Total Capital : Debt Value + Preference Value + Share Capital Value (C/S Value)

$50,000,000+$15,000,000+$35,000,000 =

$ 100,000,000.00

Solution:

1. Calculation of Weighted Average Cost of Capital [ WACC ]) WACC = Ke * Debt Value / Total Capital + Kp * Preference Share Value / Total Capital + Ke * Equity Share Capital / Total Capital

4.8% * $50,000,000 / $100,000,000 + 9% * $15,000,000 / $100,000,000 + 15% * $50,000,000 / $100,000,000

= 9%

2. Usage of WACC)

WACC is used by a firm for following purposes:

1. WACC is used to determine the valuation of the firm,

2. WACC is used to determine optimum cost of financing for the firm,


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