Question

Upton Umbrellas has a cost of equity of 10.6 percent, the YTM on the company's bonds is 5.2 percent, and the tax rate is 39 percent. The company's bonds sell for 92.6 percent of par. The debt has a book value of $378,000 and total assets have a book value of $942,000. If the market-to-book ratio is 2.44 times, what is the company's WACC?

Multiple Choice 8.86% 7.53% 4.68% 7.76% 9.09%

Answer 1

Given about Upton Umbrellas,

Cost of equity Ke = 10.6%

YTM on the company's bonds is 5.2%

For a company, its pretax cost of debt Kd equals its bond's YTM

=> Kd = 5.2%

Tax rate T = 39%

The company's bonds sell for 92.6 percent of par.

Book value of Debt = $378000

So, Market value of debt = Book value*quoted price = 378000*92.6% = $350028

Book value of assets = $942000

=> Book value of equity = 942000 - 378000 = $564000

market-to-book ratio is 2.44 times

=> Market value of equity = 2.44*564000 = $1376160

So, weight of debt Wd = MV of debt/(MV of equity + MV of debt) = 350028/(350028 + 1376160) = 0.2028

=> Weight of equity We = 1 - Wd = 1 - 0.2028 = 0.7972

So, WACC of the company = Wd*Kd*(1-T) + We*Ke = 0.2028*5.2*(1-0.39) + 0.7972*10.6 = 9.09%