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LIS Company has $50 million in long-term debt, $75 million in shareholder’s equity [both figures are...

LIS Company has $50 million in long-term debt, $75 million in shareholder’s equity [both figures are market value basis]. The cost of equity is 14%, cost of long-term debt is 12% and the tax rate is 25%. What is the weighted average cost of capital [WACC] for LIS?

LIS Company has a pretax income of $12.5 million. What is the value of the company based on correct calculation of #1?

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Answer #1

Market Value of Debt = $50 Million

Market Value of Equity = $75 Million

Total Market Value = $125 Million

Weight of Debt

Weight of Debt = Market value of debt / Total market value

= $50 Million / $125 Million

= 0.40

Weight of Equity

Weight of Equity = Market value of equity / Total market value

= $75 Million / $125 Million

= 0.60

After-tax cost of debt

After-tax cost of debt = Yield to Maturity on Debt x (1 – Tax rate)

= 12.00% x (1 – 0.25)

= 12.00% x 0.75

= 9.00%

Cost of Equity = 14.00%

Weighted Average Cost of Capital (WACC)

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

= [9.00% x 0.40] + [14.00% x 0.60]

= 3.60% + 8.40%

= 12.00%

Hence, the Weighted Average Cost of Capital (WACC) will be 12.00%

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