Question

The current stock price for a company is $49 per share, and there are 5 million shares outstanding. The beta for this firms stock is 1.6, the risk-free rate is 4.4, and the expected market risk premium is 5.6%. This firm also has 270,000 bonds outstanding, which pay interest semiannually. These bonds have a coupon interest rate of 7%, 14 years to maturity, a face value of $1,000, and a current price of 1,139.91. If the corporate tax rate is 40%, what is the Weighted Average Cost of Capital (WACC) for this firm? (Answer to the nearest hundredth of a percent, but do not use a percent sign).

Answer 1

The correct answer is 7.77

Note:

Cost of equity = risk-free rate + market risk premium * beta

= 4.4% + ( 5.6%*1.6)

= 13.36%

The Approximate Yield to Maturity Formula =[Coupon + ( Face Value - Market Price) / Number of years to maturity] / [( Face Value + Market Price)/2 ] *100

= [$ 35+ ( $ 1,000- $ 1139.91 ) /28 ] /[( $ 1,000+ $ 1139.91)/2] *100

= 30.00321429/1069.955*100

= 2.804%

Annual YTM = 2.804%*2

= 5.60%

Note : Coupon = Rate * Face Value

= 7% /2 * $ 1,000

= $35

Since this formula gives an approximate value, the financial calculators can be used alternatively.

where,

Par Value = $ 1,000

Market Price = $1139.91

Annual rate = 3.5% and

Maturity in Years = 28 Years

Hence the yield to maturity = 2.77%

Annual YTM = 2.77% * 2

= 5.54%

Now, the after tax cost of debt = Yield to Maturity * (1- tax Rate)

= 5.54% * ( 1-40%)

= 3.324%

Value of equity =  $49 per share* 5 Million Shares

Value of Debt = 270,000 bonds * 1,139.91

WACC = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

= 7.77%

		Weight ( Value / Total)	Cost	Weight * Cost
Equity	245000000	44.32	13.36%	5.92
Debt	307775700	55.68	3.32%	1.85
	552775700			7.77