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?
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%
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