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

7.33%

6.72%

9.2%

11.2%

8%

Answer 1

Market value of equity = 1 million shares*$20 per share

= $ 20 million

Value of Bank loan debt = $ 10 million

Total value of Capital Structure = $ 20 million + $10 million

= $ 30 million

Beta of company's stock = 1.2

As oer CAPM,

Rf = Risk free Return = 2%

Rm = Market return = 8%

Expected Return = 2% +1.2(8% -2%)

= 9.2%

Before tax cost of Debt = 6%

Calculating WACC:-

WACC= (Weight of Debt)(Cost of Debt)(1-Tax Rate) + (Weight of Equity)(Cost of Equity)

WACC = (10/30)(6%)(1-0.40) + (20/30)(9.2%)

WACC = 1.20% + 6.13%

WACC = 7.33%

So, the WACC of the company is 7.33%

Hence, Option A

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