Question

ABC Company has 1.4 million shares outstanding and is currently sold at $20 per share. The company’s debt is currently traded at 93 percent face value, and has a face value of $5 million. The shares are currently priced to yield 11 percent. Government Treasury bills carries a risk-free rate of 8 percent and the market risk premium is 7 percent. With a company beta of 0.74 and a corporate tax rate of 34 percent, what it’s the WACC of ABC?

Answer 1

Please check the question again. The yield of the bond should be 11%.

Before tax cost of debt = 11%

After tax cost of debt = 0.11 ( 1 - 0.34) = 0.0726 or 7.26%

Cost of equity = risk free return + beta ( market risk premium)

Cost of equity = 0.08 + 0.74 ( 0.07)

Cost of equity = 0.1318 or 13.18%

Market value of stock = 1400000 * 20 = 28,000,000

Market value of bond = 93% of 5000000 = 4,650,000

Total value = 28,000,000 + 4,650,000 = 32,650,000

WACC = Weight of stock * cost of stock + weight of bond * cost of bond

WACC = (28,000,000 / 32,650,000) * 0.1318 + (4,650,000 / 32,650,000) * 0.0726

WACC = 0.113029 + 0.010340

WACC = 0.123369 or 12.3369%