Question

Given the following information for Versa Company, find its WACC. Assume the company s tax rate is 25 percent. Debt: 40,000, 5 percent coupon bonds outstanding, $1,000 par value, 10 years to maturity, selling for 101 percent of par; the bonds make semiannual coupon payments. Common stock: 420,000 shares outstanding, selling for $44 per share; the beta is 1.68. Market: 7.0 percent market risk premium and 3.5 percent risk-free rate. (Hint: Determine the cost of debt as YTM then use the bond price to determine the market value of debt)

7.00% |
||

7.15% |
||

7.30% |
||

7.45% |
||

7.60% |

Answer #1

Market Value of Debt = 40,000 x 101% x $1,000 = $40,400,000

Market Value of Equity = 420,000 x $44 = $18,480,000

Total Market Value of Firm = Market Value of Debt + Market Value of Equity

= $40,400,000 + $18,480,000 = $58,880,000

wD = Market Value of Debt / Total Market Value of Firm = $40,400,000 / $58,880,000 = 0.6861

wE = Market Value of Equity / Total Market Value of Firm = $18,480,000 / $58,880,000 = 0.3139

To find kD, we need to put the following values in the financial calculator:

INPUT | 10*2=20 | -1,010 | (5%/2)*1,000=25 | 1,000 | |

TVM | N | I/Y | PV | PMT | FV |

OUTPUT | 2.44 |

So, kD = YTM = 2r = 2*2.44% = 4.87%

After-Tax kD = kD x (1 - t) = 4.87% x (1 - 0.25) = 3.65%

kE = rF + beta[Market Risk Premium]

= 3.5% + [1.68 * 7%] = 3.5% + 11.76% = 15.26%

WACC = [wD x After-Tax kD] + [wE x kE]

= [0.6861 x 3.65%] + [0.3139 x 15.26%]

= 2.51% + 4.79% = 7.30%

Hence, Option "C" is correct.

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