Question

The Paulson Company's year-end balance sheet is shown below. Its cost of common equity is 18%, its before-tax cost of debt is 11%, and its marginal tax rate is 25%. Assume that the firm's long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,154. The firm has 576 shares of common stock outstanding that sell for $4.00 per share.

Assets

Cash $ 120

Accounts receivable 240

Inventories 360

Plant and equipment, net 2,160

Total assets $2,880

Liabilities And Equity

Accounts payable and accruals $ 10

Short-term debt 54

Long-term debt 1,100

Common equity 1,716

Total liabilities and equity $2,880

Calculate Paulson's WACC using market-value weights.

Answer 1

WACC=(weight of debt*after tax cost of debt)+(weight of equity*cost of equity)

Cost of equity=18%

after tax cost of debt=before tax cost of debt*(1-tax rate)=11%*(1-25%)=8.25%

Market value of the debt=$1154

Market value of common equity=Outstanding shares*share price=576*4=$2304

Total value=1154+2304=3458

Weight of debt=Market value of debt/Total Value=$1154/3458=33.37%

Weight of Common equity=Market value of common equity/Total Value=$2304/$3458=66.63%

WACC=(33.37%*8.25%)+(66.63%*18%)=14.75%