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Havertown Audio has an outstanding bond issue with an total par value of $100 million. The...

Havertown Audio has an outstanding bond issue with an total par value of $100 million. The bonds are selling at a quoted price of 110% of par value and have a yield to maturity of 5.65%. The company also has 8 million shares of common stock outstanding. The stock has a beta of 1.3 and sells for $30 per share. The yield on 10 year U.S. Treasury bonds is 3% and the market risk premium is 7%. Havertown Audio has a tax rate of 21%. What is the company's weighted average cost of capital?

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Answer #1

WACC = Weight of debt * Pretax cost of debt * (1 - Tax rate) + Weight of equity * Cost of equity

Weight of debt and equity are calculated on market value basis.

Market value of debt = $100 mil * 110% = $110 mil

Market value of equity = 8mil * $30 = $240 mil

Total capital = $350 mil

Weight of debt = $110mil/$350mil = 31.43%

Weight of equity = $240mil/$350mil = 68.57%

Based on CAPM,

Cost of equity = Risk free rate + Beta * Market risk premium

Cost of equity = 3% + 1.3 * 7% = 12.1%

WACC = 31.43% * 5.65% * (1 - 21%) + 68.57% * 12.1%

WACC = 1.40% + 8.30%

WACC = 9.70%

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