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Bob's firm is a retail chain of specialty hardware stores. The firm has 21,000 shares of...

  1. Bob's firm is a retail chain of specialty hardware stores. The firm has 21,000 shares of stock outstanding that are currently valued at $68 a share. Bob’s firm stock has a beta of 1.3, expected market return is 10%, risk-free rate 1%. The firm also has 500 coupon bonds outstanding that have a face value of $1,000, a market price of $1,068, mature in 6 years and have a YTM of 5.648%. The tax rate is 35%.

Compute cost of debt

Compute cost of equity

Compute WACC

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Expert Solution

Debt:

Number of bonds outstanding = 500
Current Price = $1,068

Market Value of Debt = 500 * $1,068
Market Value of Debt = $534,000

Annual YTM = 5.648%

Before-tax Cost of Debt = 5.648%
After-tax Cost of Debt = 5.648% * (1 - 0.35)
After-tax Cost of Debt = 3.6712%

Equity:

Number of shares outstanding = 21,000
Current Price = $68

Market Value of Equity = 21,000 * $68
Market Value of Equity = $1,428,000

Cost of Equity = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Cost of Equity = 1.00% + 1.30 * (10.00% - 1.00%)
Cost of Equity = 12.70%

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $534,000 + $1,428,000
Market Value of Firm = $1,962,000

Weight of Debt = $534,000 / $1,962,000
Weight of Debt = 0.2722

Weight of Equity = $1,428,000 / $1,962,000
Weight of Equity = 0.7278

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Equity *Cost of Equity
WACC = 0.2722 * 3.6712% + 0.7278 * 12.70%
WACC = 10.24%

jeff jeffy answered 1 year ago
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