Question

BlockOut Co. has 79,172 bonds outstanding that are selling at par value. The bonds yield 8.1 percent. The company also has 5.5 million shares of common stock outstanding. The stock has a beta of 1.36 and sells for $43.6 a share. The U.S. Treasury bill is yielding 3.9 percent and the market risk premium is 7.6 percent. Blackout's tax rate is 32 percent. What is the firm's weighted average cost of capital? (Enter answer in percents.)

Answer 1

Tax rate , T = 32% = 0.32

YTM on bond = 8.1%

after tax cost of debt , rd = YTM*(1-T) = 8.1*(1-0.32) = 5.508%

price of stock , p0 = $43.60

shares outstanding , n = 5.5 million = 5,500,000

market value of equity , E = n*p0 = 5,500,000*43.6 = 239,800,000

assuming par value of bond , M= $1000

total value of debt, D = M *79,172 = 1000*79,172 = 79,172,000

treasury bill yield , rf = 3.9% = 0.039

market risk premium , MRP = 7.6% = 0.076

beta = b=1.36

cost of equity , ke = rf + (b*MRP) = 3.9 + (1.36*7.6) = 14.236%

Market value of debt + market value of equity = V = D + E = 79,172,000 + 239,800,000 = 318,972,000

D/V = 79,172,000/318,972,000 = 0.248209874

E/V = 1-(D/V) = 1-0.248209874 = 0.751790125

WACC = [(D/V)*rd] + [(E/V)*ke] = [0.248209874*5.508%] + [0.751790125 * 14.236%] = 12.06962% or 12.07% ( rounding off to 2 decimal places)