Question

The company you work for wants you to estimate the company's WACC; but before you do so, you need to estimate the cost of debt and equity. You have obtained the following information. (1) The firm's non-callable bonds mature in 20 years, have an 8.00% annual coupon, a par value of 1,000 and a market price of 1,225.00. (2) The Company's tax rate is 40%. . (3) The risk-free rate is 4.50%, the market risk premium is 5.50% and the stick's beta is 1.20. (4) The target capital structure consist of 35% debt and the balance is common equity. The Firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock.Calculate the company's component cost of debt. DO NOT USE EXCEL

Answer 1

Weight of debt = D/A

Weight of debt = 0.35

W(D)=0.35

Cost of debt

K = N

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

k=1

K =20

1225 =∑ [(8*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^20

k=1

YTM = 11.268

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

After tax cost of debt = 11.268*(1-0.4)

= 6.7608

Weighted cost of debt = weight*cost of debt = 0.35*6.76=2.37%