Question

The total book value of WTC’s equity is $10 million, and book value per share is $20. The stock has a market-to-book ratio of 1.5, and the cost of equity is 15%. The firm’s bonds have a face value of $5 million and sell at a price of 110% of face value. The yield to maturity on the bonds is 9%, and the firm’s tax rate is 40%. Find the company’s WACC.

Answer 1

Capital Structure weight based on the Market value

Market value per share = $30.00 [$20.00 x 1.50 Times]

Market value of Debt = $5.50 Million [$5.00 Million x 110%]

Market value of Equity = $15.00 Million [($10.00 Million / $20.00) x $30.00]

Total market value = $20.50 Million

Weight of Debt = 0.2683 [$5.50 Million / $20.50 Million]

Weight of Equity = 0.7317 [$15.00 Million / $20.50 Million]

After-tax Cost of Debt

After-tax Cost of Debt = YTM x (1 – Tax rate)

= 9.00% x (1 – 0.40)

= 9.00% x 0.60

= 5.40%

Cost of Equity = 15.00%

Company’s Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) = [After-tax cost debt x Weight of Debt] + [Cost of Equity x Weight of Equity]

= [5.40% x 0.2683] + [15.00% x 0.7317]

= 1.44% + 10.98%

= 12.42%

Hence, the company’s WACC will be 12.42%