Question

XYZ company has 10,000 shares of stock currently trading at $10 per share. They have a beta of 1, expected market return of 10% and a 3% risk free rate. XYZ also has 50 shares of debt outstanding currently trading at $1000 per share. Their bonds have semiannual bonds with a $1,000 par value, 5% coupon rate, and 10 years to maturity. The firm's marginal tax rate is 22 percent. Calculate the weighted average cost of capital (WACC). ENTER YOUR ANSWER AS A PERCENTAGE WITH ONE DECIMAL PLACE (e.g., 12.1) AND NOT AS A DECIMAL (e.g., 0.121). ROUND TO THE NEAREST TENTH OF A PERCENT. DO NOT USE THE PERCENT SIGN (%) IN YOUR ANSWER.

*work out step by step or by hand not on excel or any other program!*

Answer 1

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

MV of equity=10*10000

=100000

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

MV of Bond=1000*50*1

=50000

MV of firm = MV of Equity + MV of Bond

=100000+50000

=150000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 100000/150000

W(E)=0.6667

Weight of debt = MV of Bond/MV of firm

Weight of debt = 50000/150000

W(D)=0.3333

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (expected return on the market - risk-free rate)

Cost of equity% = 3 + 1 * (10 - 3)

Cost of equity% = 10

Cost of debt

K = Nx2

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

k=1

K =10x2

1000 =∑ [(5*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^10x2

k=1

YTM = 5

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

After tax cost of debt = 5*(1-0.22)

= 3.9

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

WACC=3.9*0.3333+10*0.6667

WACC =8%