Question

Here is some information about Stokenchurch Inc.: Beta of common stock = 2.1 Treasury bill rate = 4% Market risk premium = 7.4% Yield to maturity on long-term debt = 9% Book value of equity = $430 million Market value of equity = $860 million Long-term debt outstanding = $860 million Corporate tax rate = 21% What is the company’s WACC?

Answer 1

Solution:

a)Cost of common stock(Ke) as per CAPM

Ke=Risk free rate+Beta(Market Risk Premium)

=4%+2.1*7.4%

=19.54%

b)After tax cost of debt(Kd)

Kd=Cost of debt(1-tax rate)

=9%(1-0.21)=7.11%

c)Weight of Common stock(We)

We shall use market value instead of book value for computation of WACC.It is assumed that market value of debt is equal to long term debt outstanding.

Total value of capital=Value of common stock+Value of debt

=$860 million+$860 million=$1720 million

Weight of common stock(We)=Value of common stock/value of capital

=$860/$1720=0.50

d)Weight of debt(Wd)=$860/$1720=0.50

e)Calculation of WACC

WACC=Ke*We+Kd*Wd

=19.54%*0.50+7.11%*0.50

=13.325% or 13.33%