Question

Bolster Foods’ (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, r_s, is 12.00%. The company recently decided that its target capital structure should have 35% debt, with the rest of the balance being common equity. The tax rate is 40%. Calculate the WACC of the company based on target capital structures. NO EXCEL.

Answer 1

Given about Bolster Foods,

YTM on debt = 8%

=> Before-tax cost of debt of the company Kd = YTM = 8%

stockholders' required rate of return, rs, is 12.00%

=> Cost of equity Ke = 12%

The company recently decided that its target capital structure should have 35% debt, with the rest of the balance being common equity

So, based on target structure,

Weight of debt Wd = 35%

Weight of common equity We = 65%

Tax rate T = 40%

So, WACC of the company based on target capital structures = Wd*Kd*(1-T) + We*Ke

=> WACC = 0.65*12 + 0.35*8*(1-0.4) = 9.48%