Question

Question 3

XYZ is a company that does business in Brisbane. XYZ has 1 million semi-annual coupon bonds with a face value of $1000 each. At present, its bonds trade at 110% of par. The yield to maturity of the bonds is quoted at 7.5% per annum. The bonds have a coupon rate of 8.0% per annum and 15 years to maturity. The company has 150 million ordinary shares outstanding and a beta of 1.30. It currently trades at $25 per share. The market risk premium is 9.0% per annum and the risk-free rate is 4.0% per annum. XYZ is subject to 35% corporate tax rate. XYZ is planning to produce a new line of green products for Brisbane’s market. Before deciding on whether to go ahead with this potential project, the company has hired you to estimate the weighted average cost of capital (WACC) in order to evaluate the NPV analysis of this project.

1. What is the cost of equity for company XYZ?

2. What is the cost of debt for XYZ?

What is the after tax WACC for XYZ?

Answer 1

Answer :

Cost of equity ( as per CAPM) = Rf + beta (market risk premium)

= 4 + 1.3 (9)

= 4+ 11.7

= 15.70%

Cost of debt = After tax YTM

= 7.5 * ( 1 - tax rate )

= 7.5 * ( 1 - 0.35)

= 7.5 * 0.65

= 4.875%

After tax WACC = ( Weight of equity * Cost of equity ) + ( Weight if debt * Cost of debt)

Where,

Total Capital = ( 1 million * 1000 * 110% ) + ( 150 million * 25)

= 1100 million + 3750 million

= 4850 million

Weight of debt = 1100 / 4850 ==> 22.68

Weight of equity = 3750 / 4850 ==> 77.32

After tax WACC = ( 77.32% * 15.70 ) + ( 22.68% * 4.875 )

= 12.13924 + 1.10565

= 13.24489%