Question

A firm has 14 million shares of common stock outstanding with a beta of 1.15 and a market price of $42 a share. The 10 percent semiannual bonds are selling at 91 percent of par/face value. There are 220,000 bonds outstanding that mature in 17 years. The market risk premium is 6.75 percent, T-bills are yielding 3.5 percent, and the firm's tax rate is 32 percent.

1. What is the firms cost of Equity? by using CAPM
2. What is the firm’s cost of Debt? by using a calculator
3. What are the proportions of Debt and Equity in the Capital Structure?
4. What is the firm’s WACC ?

Answer 1

Beta = 1.15

Risk free rate = 3.5%

Market Risk Premium = 6.75%

Cost of Equity = 3.5% + 1.15 *  6.75%

Cost of Equity = 11.2625%

Part B

FV = 1,000

PV = 910

Number of Semi Annual Periods = 17 * 2 = 34

PMT = 10% * 1,000 * 0.5 = 50

Using Financial Calculator:

I = 5.597571%

Yearly rate = 5.597571% * 2

Yearly rate = 11.20%

Part C

Value of Equity = 14 * 10⁶ * 42

Value of Equity = 588,000,000

Value of Debt = 220,000 * 910

Value of Debt = 200,200,000

Value of firm = 588,000,000 + 200,200,000

Value of firm = 788,200,000

Proportion of Equity = 588,000,000/ 788,200,000

Proportion of Equity = 0.746003

Proportion of Debt = 1 - 0.746003

Proportion of Debt = 0.253996

Part D

WACC = 0.746003 * 11.2625% + 0.253996 * 11.20% * (1 - 32%)

WACC = 10.34%