Question

19.

Fun & Games Entertainment Inc. is in the process of evaluating a new theme park construction project. Obviously, they need a discount rate for their NPV calculation and will use the company's WACC. Use the information below to calculate the weighted average cost of capital (WACC):

• The company has 1,000,000 shares on issue.
• The shares trade at $17.90 and have a Beta of 1.40.
• The expected return on the market is 8% and the risk free rate is 3%.
• The company has 20,000 bonds on issue.
• The bonds trade at $104 and have a yield to maturity of 5%.
• The corporate taxation rate is 30%.

Select one:

a. 8.15%

b. 4.57%

c. 9.32%

d. 10.33%

e. 11.23%

Answer 1

Market value of equity = 1000000*$17.90

= $17900000

Market value of Debt = 20000*$104

= $2080000

Cost of equity is calculated below

Cost of equity = Risk free rate + Beta*(Market return - Risk free rate)

= 3 + 1.40*(8-3)

= 10%

WACC = Cost of Equity*(Market value of Equity/(Market value of Debt+Market value of Equity)) + Cost of Debt*(Market value of Debt/(Market value of Debt+Market value of Equity))*(1-tax rate)

WACC = 10*($17900000/($2080000+$17900000)) + 5*($2080000/($2080000+$17900000))*(1-0.30)

= 8.9590 + 0.3644

= 9.32%

Therefore, correct option is c.