Daves Inc. recently hired you as a consultant to estimate the company’s WACC. You have obtained the following information. (1) The firm's bonds have a YTM of 6%. (2) The company’s tax rate is 30%. (3) The risk-free rate is 4%, the market risk premium is 5%, and the stock’s beta is 1.10. (4) The target capital structure consists of 30% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares. What is its WACC?
| Cost of debt | |||
| Cost of debt | 6.00% | ||
| Tax rate | 30% | ||
| After-tax cost of debt | =6%*(1-30%) | ||
| After-tax cost of debt | 4.20% | ||
| Cost of equity stock | |||
| Cost of equity= | Risk free rate + beta * Market risk premium | ||
| Cost of equity= | 4% + 1.1 * 5% | ||
| Cost of equity= | 9.500% | ||
| Calculation of WACC | |||
| Cost | Weight | Weighted cost | |
| A | B | C=A*B | |
| Debt | 4.20% | 30.00% | 1.26% |
| Equity | 9.50% | 70.00% | 6.65% |
| Total capital | Total WACC | 7.91% | |
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