Question

The company has a target D/E ratio = 2/3. ⚫ Bonds with face value of $1,000 pay a 10% coupon, mature in 20 years, and sell for $849.54. ⚫ The company stock beta is 1.2. ⚫ Risk-free rate is 10%, and market risk premium is 5%. ⚫ The company is a constant-growth firm that just paid a dividend of $2, sells for $27 per share, and has a growth rate of 8%. ⚫ The company’s marginal tax rate is 40%. What is the company’s weighted average cost of capital?

Answer 1

Solution :-

Coupon Amount = $1,000 * 10% = $100

Time ( Nper ) = 20

Face Value ( FV ) = $1,000

Price ( PV ) = - $849.54

Cost of Debt ( YTM)  =

Cost of Debt ( kd ) = 12.17%

After tax Cost of Debt = 12.17% * ( 1 - 0.40 ) = 7.30%

Cost of Equity ( Ke ) = Rf + Beta * ( Risk Premium )

= 10% + 1.2 * ( 5% )

= 16%

Now Weight of Debt = 2 / ( 2 + 3 ) = 2 / 5

Weight of Equity = 3 / ( 2 + 3 ) = 3 / 5

Now WACC = ( 7.30% * 2 / 5 ) + ( 16% * 3 / 5 )

= 12.52%

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