Question

Daves Inc. recently hired you as a consultant to estimate the company’s Weighted Average

Cost of Capital. You have obtained the following information: 1. There is no preferred equity in

the company’s capital structure. 2. The company’s debt is financed through issuing corporate

bond and now the yield to maturity of this bond is 8%. 3. The company’s common stock has an

estimated return of 10%. 4. The tax rate is 40%. 5. The bond price is $900 per unit and there are

1 million units of bond issued. 6. The common stock is priced at $10 per share and there are 10

million stock shares outstanding. What is the firm’s WACC based on market value?

Answer 1

WACC is calculated by using the formula below:

WACC= wd*kd(1-t)+we*ke

where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

Cost of debt= 8%

Cost of equity= 10%

Tax rate= 40%

Debt in the capital structure: $900* 1,000,000 = $900,000,000

Equity in the capital structure: $10* 10,000,000= $100,000,000

Total firm capital = $900,000,000 + $100,000,000= $10,000,000.

Weight of debt in the capital structure= $900,000,000/ $10,000,000 =0.90

Weight of equity in the capital structure: $100,000,000/ $10,000,000= 0.10

WACC= 0.90*8%(1-0.40) + 0.10*10%

            = 0.90*4.80 + 0.10*10%

            = 4.32% + 1% = 5.32%.