Question

# Advance Manufacturing has 8.2 million shares of common stock outstanding. The current share price is \$50,...

Advance Manufacturing has 8.2 million shares of common stock outstanding. The current share price is \$50, and the book value per share is \$8.

The company has 200,000 9% coupon bonds outstanding, \$1,000 par value, 15 years to maturity, currently selling for 97% of par, and the bonds make annual payments.

Suppose the company’s stock has a beta of 1.3. The risk free rate is 3.5%, and the market risk premium is 7%. The company’s tax rate is 35%.

 Market value Common stock (8.2 million * \$50) 410000000 Debt (200000*1000 * 97%) 194000000 Total 604000000

Cost of common stock

Required rate of return = risk free rate + market risk premium * beta

= 3.5% + 1.3*7%

= 3.5% + 9.1%

= 12.6%

Cost of debt (after tax)

Yield to maturity (approx.) = {interest payment + [face value - current price]/ yield to maturity} / [face value + current price]/ 2] * (1+ tax)

= {(1000*9%) + [1000-970]/15} / ([1000+970]/2) * (1- 0.35)

= {90 + 2} / 985 * 0.65

= 92 / 985 * 0.65

= 6.097%

WACC for the company :

 market value Weightage Cost of capital WACC Common stock 410000000 0.68 12.6% 8.568% Debt 194000000 0.32 6.097% 1.951% 604000000 10.52%

WACC for the company = 10.52%

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