Question

OASIS's outstanding 11% coupon rate debentures mature in 15 years, pay interest semiannually and are callable at $1,015 in 3 years. The bonds are selling at $1,218. OASIS has a beta of 1.5, the risk free rate is 3% and the expected return on the market is 12%. OASIS optimal capital structure is thought be 55% debt and 45% common equity. Tax rate is 35%. Calculate OASIS's WACC.

A. 9.10%

B. 8.76%

C. 11.03%

D. 10.56%

E. 12.10%

Answer 1

Cost of debt

Using financial calculator BA II Plus - Input details:	#
FV = Call price =	$1,015.00
PV = Bond price =	$1,218.00
PMT = Coupon =	$55.00
N = Year to call =	6
CPT > I/Y = Rate =	1.8645
Yield to call or Return Investors should expect to earn in % = Rate x 2 =	3.7290%

Cost of equity:

Cost of equity = Risk free rate + Beta x (Market return - Risk free rate)

Cost of equity = 3% + 1.5 x (12% - 3%)

Cost of equity = 16.50%

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WACC = Cost of equity x Weight of equity + Cost of debt x Weight of debt x (1-Tax rate)

WACC = 16.5% x 45% + 3.7290% x 55% x (1-35%)

WACC = 8.76%

Correct option is > B. 8.76%