Question

18. Coleman Technologies Inc. is estimating its WACC

Tax rate = 40%.

Debt value: $15,000. Par value $1,000, 15-year, 12% coupon, semiannual payment bonds sell for $1,153.72.

Shares outing standing: 1000 shares with $35/share. Beta = 1.2; Risk-free rate = 7%; Market risk premium = 6%. Use the above information to answer Q1-4

Q1) What is the company's bond YTM?

a)11.5%

b)10%

c)9.5%

d)9%

Q2)What is the company's after-tax cost of debt?

a)6.6%

b)5.4%

c)6%

d)5.7%

Q3) What is the company's cost of equity?

a)14.2%

b)15.3%

c)13.9%

d)12.5%

Q4) What is the company's WACC

a)10.65%

b)12.53%

c)11.74%

d)13.21%

Answer 1

1

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =15x2

1153.72 =∑ [(12*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^15x2

k=1

YTM = 10.00

2

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 10.0000526755*(1-0.4)

= 6.00

3

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 7 + 1.2 * (6)

Cost of equity% = 14.2

4

MV of equity=Price of equity*number of shares outstanding

MV of equity=35*1000

=35000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*13.0014214887494*1.15372

=15000

MV of firm = MV of Equity + MV of Bond

=35000+15000

=50000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 35000/50000

W(E)=0.7

Weight of debt = MV of Bond/MV of firm

Weight of debt = 15000/50000

W(D)=0.3

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=6*0.3+14.2*0.7

WACC =11.74%