Question

The current stock price for a company is $46 per share, and there are 7 million shares outstanding. The beta for this firms stock is 1, the risk-free rate is 4.5, and the expected market risk premium is 5.5%. This firm also has 250,000 bonds outstanding, which pay interest semiannually. These bonds have a coupon interest rate of 9%, 12 years to maturity, a face value of $1,000, and a current price of 1,147.61. If the corporate tax rate is 31%, what is the Weighted Average Cost of Capital (WACC) for this firm? (Answer to the nearest hundredth of a percent, but do not use a percent sign).

Answer 1

According to the CAPM,

Ke = Rf + [Market Risk Premium]

= 4.5% + 1[5.5%] = 10%

To find the Kd, we need to put the following values in the financial calculator;

INPUT	12X2 = 24		-$1,147.61	$45	$1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		3.57%

This is a semi-annual YTM. So, Annual YTM = 3.57% x 2 = 7.15%

Market Value of Equity = $46 x 7,000,000 = $322,000,000

Market Value of Debt = $1,147.61 x 250,000 = $286,902,500

Total Market Value = Market Value of Equity + Market Value of Debt

= $322,000,000 + $286,902,500 = $608,902,500

WACC = [Wd x Kd(1 - t)] + [We x Ke]

= [($286,902,500/$608,902,500) x 7.15% x (1 - 0.31)] + [($322,000,000/$608,902,500) x 10%]

= 2.32% + 5.29% = 7.61%