Assume that you have been hired as a consultant by CGT, a major
producer of chemicals and plastics, including plastic grocery bags,
styrofoam cups, and fertilizers, to estimate the firm's weighted
average cost of capital. The balance sheet and some other
information are provided below.
Assets
Current assets 
$38,000,000 
Net plant, property, and equipment 
$101,000,000 
Total assets 
$139,000,000 
Liabilities and Equity
Accounts payable 
$10,000,000 
Accruals 
$9,000,000 
Current liabilities 
$19,000,000 
Longterm debt (40,000 bonds, $1,000 par value) 
$40,000,000 
Total liabilities 
$59,000,000 
Common stock (10,000,000 shares) 
$30,000,000 
Retained earnings 
$50,000,000 
Total shareholders' equity 
$80,000,000 
Total liabilities and shareholders' equity 
$139,000,000 
The stock is currently selling for $17.75 per share, and its
noncallable $3,319.97 par value, 20year, 1.70% bonds with
semiannual payments are selling for $881.00. The beta is 1.29, the
yield on a 6month Treasury bill is 3.50%, and the yield on a
20year Treasury bond is 5.50%. The required return on the stock
market is 11.50%, but the market has had an average annual return
of 14.50% during the past 5 years. The firm's tax rate is 40%.
Refer to Exhibit 10.1. What is the best estimate of the firm's WACC? Do not round your intermediate calculations.
a. 
12.11% 

b. 
11.26% 

c. 
12.97% 

d. 
12.59% 

e. 
11.74% 
Rf = the yield on a 20year Treasury bond = 5.50%
Cost of equity, Ke = Rf + Beta x (Rm  Rf) = 5.50% + 1.29 x (11.50%  5.50%) = 13.24%
Cost of debt, Kd = YTM of the bond = 2 x semi annual yield = 2 x RATE (Nper, PMT, PV, FV) = 2 x RATE (2 x 20, 1.70% x 3319.97 / 2, 881, 3319.97) = 10.64%
market value of Debt, D = Price x Number of bonds = 881 x 40,000 = $ 35.24 million
Market value of equity = P x N = 17.75 x 10 million = $ 177.50 million
Wd = proporton of debt in captal structure = D / (D + E) = 35.24/(35.24 + 177.5) = 16.56%
We = proportion of equity = 1  Wd = 1  16.56% = 83.44%
Tax rate, T = 40%
Hence, WACC = Wd xKd x (1  T) + We x Ke = 16.56% x 10.64% x (1  40%) + 83.44% x 13.24% = 12.11%
Hence, the correct answer is the first option i.e. option a. 12.11%
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