Question

Gerdin Inc. has one million shares outstanding with a price of $20/share. The beta of the company's stock is 1.2. The risk-free rate and the expected return of the market portfolio are 2% and 8% respectively. Other than the stocks, the company also has $10 million bank loan. The interest rate on the loan is 6% per year. The tax rate of the company is 40%. Calculate the WACC of the company.

Group of answer choices

8%

6.72%

9.2%

7.33%

11.2%

Answer 1

The WACC is computed as shown below:

= cost of debt (1 - tax rate) x weight of debt + cost of equity x weight of equity

cost of equity is computed as follows:

= risk free rate + beta (return on market - risk free rate)

= 0.02 + 1.2 (0.08 - 0.02)

= 9.2% or 0.092

So, the WACC will be computed as follows:

= 0.06 (1 - 0.40) x $ 10 million / [ ( $ 10 million + $ 20 x 1 million) ] + 0.092 x ($ 20 x 1 million) / [ ( $ 10 million + $ 20 x 1 million) ]

= 0.036 x $ 10 million / $ 30 million + 0.092 x $ 20 million / $ 30 million

= 0.012 + 0.0613333

= 7.33% Approximately

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