Question

The current stock price for a company is $43 per share, and there are 7 million shares outstanding. The beta for this firms stock is 1.1, the risk-free rate is 4.8, and the expected market risk premium is 6.5%. This firm also has 290,000 bonds outstanding, which pay interest semiannually. These bonds have a coupon interest rate of 9%, 18 years to maturity, a face value of $1,000, and an annual yield to maturity of 8.3%. If the corporate tax rate is 33%, what is the Weighted Average Cost of Capital (WACC) for this firm? (Answer to the nearest hundredth of a percent, but do not use a percent sign).

Answer 1

K = Nx2

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

k=1

K =18x2

Bond Price =∑ [(9*1000/200)/(1 + 8.3/200)^k]     +   1000/(1 + 8.3/200)^18x2

k=1

Bond Price = 1064.83 = 1.06483 of par

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

MV of equity=43*7000000

=301000000

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

MV of Bond=1000*290000*1.06483

=308800700

MV of firm = MV of Equity + MV of Bond

=301000000+308800700

=609800700

Weight of equity = MV of Equity/MV of firm

Weight of equity = 301000000/609800700

W(E)=0.4936

Weight of debt = MV of Bond/MV of firm

Weight of debt = 308800700/609800700

W(D)=0.5064

Cost of equity

As per CAPM

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

Cost of equity% = 4.8 + 1.1 * (6.5)

Cost of equity% = 11.95

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

After tax cost of debt = 8.3*(1-0.33)

= 5.561

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

WACC=5.56*0.5064+11.95*0.4936

WACC =8.71%