Question

Jack's Construction Co. has 100,000 bonds outstanding that are selling at par value. The bonds yield 9.3 percent. The company also has 3.8 million shares of common stock outstanding. The stock has a beta of 1.6 and sells for $65 a share. The U.S. Treasury bill is yielding 6 percent and the market risk premium is 9 percent. Jack's tax rate is 35 percent. What is Jack's weighted average cost of capital? 13.70% 15.53% 14.98% 17.54% 16.26%

Answer 1

The weighted average cost of capital is computed as shown below:

= cost of debt (1 - tax rate) x weight of debt + cost of equity x weight of equity

cost of equity is computed as follows:

= risk free rate + beta x market risk premium

= 0.06 + 1.6 x 0.09

= 20.4% or 0.204

So, the WACC will be computed as follows:

= 0.093 (1 - 0.35) x [ ($ 100,000,000) / ( $ 100,000,000 + 3,800,000 x $ 65)] + 0.204 x [ (3,800,000 x $ 65) / ( $ 100,000,000 + 3,800,000 x $ 65)]

= 0.06045 x ($ 100,000,000 / $ 347,000,000) + 0.204 x ($ 247,000,000 / $ 347,000,000)

= 0.017420749 + 0.145210375

= 16.26% Approximately

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