Question

The company your work for wants you to estimate the company's WACC; but you do so, you need to estimate the cost of debt and equity. You have obtained the following information.

(1) The firm's non-callable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,225.00.

(2) The company's tax rate is 40%.

(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 equiry, and it does bot expect to issue ant new common stock.

- WHAT IS ITS WACC?

- CALCULATE THE COMPANY's COMPONENT COST OF DEBT

- CALCULATE THE COMPANY's COST OF RETAINED EARNINGS USING THE CAPM APPROACH.

Answer 1

Bond
Yield to maturity= (Coupon+((Face value-Price)/Number of years to maturity))/((Face value+Price)/2)
		(80+((1000-1225)/20))/((1000+1225)/2)
		6.18%
Annual Coupon= Face value*Coupon rate
	$1000*8%
	$80
After tax cost of debt= Yield to maturity*(1-tax rate)
		6.18*(1-0.40)
		3.708%
Equity stock
Cost of equity= Risk free rate+Market risk premium*Beta
		4.50+5.5*1.20
		11.10%
Calculation of WACC
WACC= Weighted average
	(0.35*3.708)+(0.65*11.10)
	8.5128%