Question

Q1) Jack's Construction Co. has 80,000 bonds outstanding that are selling at their par value of $1,000 each. The bonds have a coupon rate and YTM of 8.6 percent. The firm also has 4,000,000 shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. T-bill is yielding 4 percent, the market risk premium is 8 percent, and the firm's tax rate is 21 percent.

(a) What is the firm’s cost of equity?

(b) What is the firm’s after-tax cost of debt?

(c) What is the firm's weighted average cost of capital?

Answer 1

a) firm’s cost of equity = risk free rate + market risk premium *beta

= 4%+8%*1.1

= 12.80%

Answer = 12.80%

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b) after-tax cost of debt = YTM*(1- tax rate)

= 8.6%*(1-21%)

= 6.794%

Answer = 6.794%

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c) Answer = 8.80%

Value of Bond = 80,000 bonds outstanding * $1,000 each

Value of Equity =  4,000,000 shares of common stock outstanding * $40 a share

Total Value = Value of Bond + Value of Equity

WACC = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

= 8.80%

Note:

	Value	Weight(value / total)	Cost	Weight * cost
Debt	8,00,00,000.00	33.33	12.80%	4.27
Equity	16,00,00,000.00	66.67	6.794%	4.53
Total	24,00,00,000.00		WACC=	8.80 %