Question

The following data applies to Micro Advanced Developers (MAD).

Debt Equity

market value of debt = $198,092   market value of equity = $244,069

time to maturity of debt = 14 years risk free rate = 3.0% pa

coupon rate = 3.0% pa paid semi-annually market risk premium = 7.7% pa

face value = $300,000 DDD beta = 0.87

As a financial manager you have been given the task of calculating the company's weighted average cost of capital (WACC). Ignore the effect of taxes.

a)Firstly, you realise that the cost of debt is needed. Calculate the cost of debt for MAD. You may give your answer as a percentage per annum to the nearest percent or use linear interpolation or a financial calculator to give a more accurate result. Cost of debt = _____% pa

b)Secondly, the cost of equity must also be identified. Calculate the cost of equity for MAD. Give your answer as a percentage per annum to 1 decimal place. Cost of equity = ______% pa

c)Finally, calculate the weighted average cost of capital for MAD. Give your answer as a percentage per annum to 1 decimal place. Weighted average cost of capital = ____% pa

Answer 1

a. For cost of debt, we calculate the yield on the debt. 0.077 x 300000/2 = 23100/2 = coupon payment = 11550

198092 = 11550/(1+r) + 11550/(1+r)^2 + ............... + 11550/(1+r)^28 + 300000/(1+r)^28

r = 6.5204%. Hence, annual cost of debt = 6.52 x 2 = 13.04%

b. We use CAPM to calculate the cost of equity. Re= Rf + Beta(Rm-Rf)

Re= 3 + 0.87 x 7.7 = 9.7%.

c. WACC = Rd x D/(D+E) + Re x E/(D+E) (Ignoring taxes)

WACC = 13.04 x 198092/(198092 + 244069) + 9.7 x 244069/(198092 + 244069) = 11.196% = 11.2%.