Question

Upton Umbrellas has a cost of equity of 10.9 percent, the YTM on the company's bonds is 5.6 percent, and the tax rate is 40 percent. The company's bonds sell for 94.1 percent of par. The debt has a book value of $390,000 and total assets have a book value of $946,000. If the market-to-book ratio is 2.56 times, what is the company's WACC?

Answer 1

The WACC is computed as shown below:

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

Amount of debt is computed as follows:

= Book value of debt x 94.1%

= $ 390,000 x 94.1%

= $ 366,990

Amount of equity is computed as follows:

= (Book value of Total Assets - Book value of debt) x 2.56 times

= ($ 946,000 - $ 390,000) x 2.56

= $ 1,423,360

So, the WACC will be computed as follows:

= [ 0.056 x (1 - 0.40) x $ 366,990 / ($ 366,990 + $ 1,423,360) ] + [ 0.109 x $ 1,423,360 / ($ 366,990 + $ 1,423,360) ]

= 0.688740414% + 8.6656933%

= 9.35% Approximately

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