Question

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.

What is the cost of equity for company XYZ?

What is the cost of debt for XYZ?

What is the after tax WACC for XYZ?

Answer 1

1) Cost of equity = Risk free rate of return + Beta( Market risk premium)

Thus Cost of equity = 4% + 1.3(9%)

=4% + 12%

= 16%

2) Cost of debt = YTM(1-Tax rate)

= 7.5%(1-0.35)

=7.5%(0.65)

= 4.875%

3) Market value of equity = No. of shares x price per share

=  150 million x 25$

= $ 3750 millions

Market value of bonds = No. of bonds x market price per bond

= 1 million bonds x (1000 x 110%)

= 1 million bonds x 1100

= $1100 milion

Statement showing WACC

Particulars (Figure in mln)	Amount	Weight	Cost of capital	WACC
	a	b	c =axb
Equity	3750.00	77%	16.00%	12.37%
Debt	1100.00	23%	4.88%	1.11%
WACC	4850.00			13.48%

Thus WACC = 13.48%