Question

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

Debt	Equity
market value of debt = $265,498	market value of equity = $664,888
time to maturity of debt = 10 years	risk free rate = 5.0% pa
coupon rate = 6.4% pa paid semi-annually	market risk premium = 8.4% pa
face value = $300,000	DDD beta = 0.88

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

NOTE:

ALL FINAL ANSWERS WERE ROUNDED TO ONE DECIMAL PLACE.

Cost of Debt:

Cost of Debt= [ Interest + ( Face- Premium Value)/N ] / (Face+premium)/2

Interest =( 6.4%/2 )*Face value= 3.2% * 300000= 9600

n= 10 * 2=20 ( becasue of semi annual payments)

So COD= 9600+ {300000- 265498}/20 / (300000+265498 )/2

COD= 0.04%

FOr annual payment it is 0.04% *2 =8.0%

Cost of equity:

CAPM formula Exp. return= Risk free rate+ Beta * market risk premium

Exp. return= 0.05+ (0.88*0.084)=

Cost of equity =12.4%

WACC

weight of Debt=265498/( 664,888+265498)= 0.285363279

Weight of Equity= 664,888 /( 664888+265498)=0.714636721

WACC= coe * wt of equity + cod* wt of debt * (1-tax)

here tax =0

WACC= 12.4%*0.714636721+ 8%* 0.285363279
WACC=11.1%