Question

Daves Inc. recently hired you as a consultant to estimate the company’s WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,000.00. (2) The company’s tax rate is 25%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock’s beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC? Do not round your intermediate calculations.

Answer 1

Calculating Before tax Cost of Debt (Kd),

using financial calculator,

PV	-1000
PMT	80
n	20
FV	1000
Compute IY	8%

Before tax cost of Debt IY = 8%

After tax cost of Debt = Before tax cost of debt (1-tax rate)

After tax cost of Debt = 8% (1-25%)

After tax cost of Debt =6%

Calculating Cost of Equity

As per CAPM,

Cost of Equity =Risk free Rate + (Beta x Market Risk Premium)

Cost of Equity =4.5%+(1.2*5.5%)

Cost of Equity = 11.10%

Weight of Debt = 35%

Weight of Equity = 100%-35% =65%

WACC = (Weight of Equity * cost of Equity) + (Weight of debt * cost of debt)

WACC = (65%*11.10)+ (35%*6)

WACC=9.315%

Thumbs up Please! Thank You