Question

Telefonica has 100 million shares and the price per share is $200. It also has 10 million zero coupon bonds with a price per bond of $850 and YTM of 4%. Tax rate is 30%. If the cost of equity is 10%. What is the WACC for Telefonica?

Answer 1

Capital Structure weight based on the Market value

Market value of Debt = $8,500 Million [10 Million shares x $850]

Market value of Equity = $20,000 Million [100 Million shares x $200]

Total market value = $28,500 Million

Weight of Debt = 0.2982 [$8,500 Million / $28,500 Million]

Weight of Equity = 0.7018 [$20,000 Million / $28,500 Million]

After-tax Cost of Debt

After-tax Cost of Debt = YTM x (1 – Tax rate)

= 4.00% x (1 – 0.30)

= 4.00% x 0.70

= 2.80%

Cost of Equity = 10.00% (Given)

Company’s Weighted Average Cost of Capital (WACC)

Therefore, the Weighted Average Cost of Capital (WACC) = [After-tax cost debt x Weight of Debt] + [Cost of Equity x Weight of Equity]

= [2.80% x 0.2982] + [10.00% x 0.7018]

= 0.83% + 7.02%

= 7.85%

Hence, the WACC for Telefonica will be 7.85%