Question

Power Financial Corp has a current share price of​ $30, and a market capitalization of​ $20 billion. The​ firm's beta is​ 0.93, the​ risk-free rate is​ 3.2%, and the market risk premium is​ 7%. The firm has​ $12 billion of debt with a yield to maturity of​ 5%. If the​ firm's tax rate is​ 20%, what is Power​ Financial's WACC?

Answer 1

Debt:

Annual YTM = 5%

Before-tax Cost of Debt = 5%
After-tax Cost of Debt = 5% * (1 - 0.20)
After-tax Cost of Debt = 4%

Value of Debt = $12,000,000

Equity:

Value of Common Stock = $20,000,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 3.2% + 0.93 * 7%
Cost of Common Equity = 9.71%

Value of Firm = Value of Debt + Value of Common Stock
Value of Firm = $12,000,000 + $20,000,000
Value of Firm = $32,000,000

Weight of Debt = $12,000,000/$32,000,000
Weight of Debt = 0.375

Weight of Common Stock = $20,000,000/$32,000,000
Weight of Common Stock = 0.625

WACC = Weight of Debt*After-tax Cost of Debt + Weight of Common Stock*Cost of Common Stock
WACC = 0.375*4% + 0.625*9.71%
WACC = 0.0757 or 7.57%