Question

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

Debt	Equity
market value of debt = $145,773	market value of equity = $112,968
time to maturity of debt = 8 years	risk free rate = 3.3% pa
coupon rate = 2.1% pa paid semi-annually	market risk premium = 4.9% pa
face value = $200,000	DDD beta = 1.10

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

Weighted Average cost of capital = Weight of equity *cost of equity + weight of debt *cost of debt after taxes

a) cost of debt = semi annual coupon rate * 2 * (1-tax) = 2.1%*2 = 4.2%

Cost of debt = 4.2 % pa

b) cost of equity = risk free rate + beta * market risk premium = 3.3% + 1.1*4.9% = 3.3% 5.4% = 8.7%

Cost of equity = 8.7 % pa

c) weight of equity = Market value of equity / ( market value of debt + market value of equity ) = 112968 / ( 145773 + 112968 ) = 112968/258741 = 43.7%

Weight of debt = 1 - weight of equity = 1- 43.7% =53.3%

WACC = we *ce + wd*cd = 43.7%*8.7% + 53.3%*4.2% =3.8%+2.24% = 6.04%

Weighted average cost of capital = 6.04 % pa