Question

Bolster Foods’ (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, r_s, is 12.00%. The company recently decided that its target capital structure should have 35% debt, with the rest of the balance being common equity. The tax rate is 40%. Calculate the WACC of the company based on target capital structures.

Answer 1

WACC = weight of debt*after-tax cost of debt + weight of equity*cost of equity

target capital structure has 35% debt which means it has 100% - 35% = 65% equity. target capital structure will always have 100% weight in the form of debt, common stock and/or preferred stock.

cost of debt is yield to maturity on the debt which is 8%.

after-tax cost of debt = cost of debt*(1-tax rate) = 8%*(1-0.40) = 8%*0.60 = 4.8‬%

cost of equity is the required return by stockholders which is 12%.

WACC = 0.35*4.8% + 0.65*12% = 1.68% + 7.8‬% = 9.48‬%

the WACC of the company based on target capital structures is 9.48%.