Question

The company has a market value of debt of $200m and market value of equity of $900m. The beta of the company is 0.8. The risk-free rate is currently 4 per cent per annum and the company can borrow at 2 per cent per annum above the risk-free rate. They pay corporation tax at 30 per cent. The expected return on the market is 10 per cent per annum. Calculate Strachan's current weighted average cost of capital.

Answer #1

Value (in million $) | Weights | ||||||

Debt | 200 | 0.181818 | 200/1100 | ||||

Equity | 900 | 0.818182 | 900/1100 | ||||

1100 | 1 | ||||||

Cost of debt | 4% + 2% | 6% | |||||

After tax cost of debt | 6%(1-0.30) | 0.042 | 4.20% | ||||

Cost of Equity | Risk Free rate + Beta*(Market rate of return - Risk free rate) | ||||||

0.04+ 0.80(0.10-0.04) | |||||||

0.04 + 0.80*0.06 | |||||||

8.80% | |||||||

WACC of Strachan's | Cost of Debt*weight of debt + Cost of equity*weight of equity | ||||||

0.042*(200/1100) + 0.088*(900/1100) | |||||||

0.007636 + 0.072 | |||||||

0.079636 | |||||||

7.96% | |||||||

WACC of Strachan's is 7.96% | |||||||

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