Question

Given the following information for Silicon Tech, find its WACC. Assume the company s tax rate is 25 percent. Debt: 30,000, 5.5 percent coupon bonds outstanding, $1,000 par value, 10 years to maturity, selling for 98 percent of par; the bonds make semiannual coupon payments. Common stock: 400,000 shares outstanding, selling for $40 per share; the beta is 1.60. Market: 7.0 percent market risk premium and 4.5 percent risk-free rate.

Answer #1

Market Value of debt = 30,000 x $1,000 x 0.98 = $29,400,000

Market Value of equity = 400,000 x $40 = $16,000,000

Total Market Value = Market Value of debt + Market Value of equity

= $29,400,000 + $16,000,000 = $45,400,000

According to the CAPM,

Ke = rF + beta[market risk premium]

= 4.5% + [1.60 x 7%] = 4.5% + 11.2% = 15.7%

To find the YTM, we need to put the following values in the financial calculator:

INPUT | 10x2=20 | -980 | (5.5%/2)x1,000 = 27.5 | 1,000 | |

TVM | N | I/Y | PV | PMT | FV |

OUTPUT | 2.88 |

As r = 2.88%. So, YTM = 2r = 2 x 2.88% = 5.77%

WACC = [wD x kD x (1 - t)] + [wE x kE]

= [($29,400,000 / $45,400,000) x 5.77% x (1 - 0.25)] +

[($16,000,000 / $45,400,000) x 15.7%]

= 2.80% + 5.53% = 8.33%

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