Question

To estimate the company's WACC, Marshall Inc. recently hired you as a consultant. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00. (2) The company's tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares. What is its WACC?

Answer 1

Answer:

After tax cost of debt:

Par value = FV = $1000

Annual coupon = PMT = 1000 * 8% = $80

Time to maturity = NPER = 20 Years

Price = PV = $1050

Before tax cost of debt = RATE(nper, pmt, pv, fv, type) = RATE (20, 80, -1050, 1000, 0) = 7.51%

Aftertax cost of debt = 7.51% * (1 - 40%) = 4.51%

Cost of Equity:

Using CAPM model:

Cost of equity = Rf + Beta * Rp = 4.50% + 1.20 * 5.50% = 11.10%

Capital Structure:

Debt = 35%

Equity = 1 - 35% = 65%

WACC:

WACC = Cost of equity * weight of equity + After-tax cost of debt * weight of debt

= 11.10% * 65% + 4.51% * 35%

= 8.79%

WACC = 8.79%