In: Finance
Given the following information about your firm’s capital structure, calculate your firm’s WACC (assume the corporate tax rate is 35%). Debt Number of bonds outstanding = 12,000 price per bond = $1,165 par value per bond = $1,000 coupon rate = 6% (paid annually) Years to maturity = 10 Common Stock Number of shares outstanding = 1,000,000 Price per share = $25 Book value per share = $15 Beta = 1.4 Risk free rate = 4.5% Market risk premium = 5%
Market value of debt= $1,165*12,000= $13,980,000.
Market value of equity= $25*1,000,000= $25,000,000
Total firm value= $13,980,000 + $25,000,000 = $38,980,000.
Weight of debt in the capital structure= $13,980,000/ $38,980,000
= 0.3586*100
= 35.86%
Weight of equity in the capital structure= $25,000,000/ $38,980,000
= 0.6414*100
= 64.14%
The cost of equity is calculated using the Capital Asset Pricing Model (CAPM) which is calculated using the formula below:
Ke=Rf+[E(Rm)-Rf]
Where:
Rf=risk-free rate of return
Rm=expected rate of return on the market.
Rm- Rf= Market risk premium
= stock’s beta
Ke= 4.5% + 1.4*5%
= 4.5% + 7%
= 11.50%
The cost of debt is calculated by computing the yield to maturity.
Par value= future value= $1,000
Current price= market value= $1,165
Coupon rate= 6%
Coupon payment= 0.06*1,000= $60
Time= 10 years
The yield to maturity is calculated by entering the below in a financial calculator:
FV= 1,000
PV= 1,165
PMT= 60
N= 10
Press the CPT key and I/Y to compute the yield to maturity.
The value obtained is 3.9689.
Therefore, the yield to maturity is 3.97%.
WACC= wd*kd(1-t)+we*ke
Where:
Wd=percentage of debt in the capital structure
We=percentage of equity in the capital structure
Kd=cost of debt
Ke=cost of equity
t= tax rate
WACC= 0.3586*3.97*(1- 0.35) + 0.6414*11.50%
= 0.9254 + 7.3761
= 8.3015%8.30%.