Question

A company has 3 million shares outstanding at a market price of $1.50 each. The company's bonds have a total market value of $2,700,000, have a coupon rate of 3% p.a. and currently yield 4% p.a. The current market value of preference shares is $500,000 and currently return 5% p.a. The company has a beta of 0.7, the market risk premium is 6% p.a., the risk-free return is 2% p.a., and the company tax rate is 30%,

What is the firm's weighted average cost of capital (WACC)?

Answer 1

Inputs

Shares: 3 million shares outstanding

Market price = $1.50

Market value of equity = $4.5 million

Market Value of Debt = $2,700,000

Cost of Debt = 4% p.a

Market value of preference shares = $500,000

Costy of Preference = 5% p.a

MV of enterprise = MV of Debt + MV of Equity + MV preference =

$2.7+4.5+0.5 = $ 7.7 million

Beta = 0.7

Market risk premium = 6% p.a

Risk-free return = 2% p.a

Tax rate = 30%

Cost of Equity = Risk Free return + Beta * Market risk premium

Cost of Equity = 2%+0.7*6% = 6.2%

To find weighted cost of capital we use the following metric

Cost of Debt * MV of Debt /MV of Enterprise * (1-tax rate) + Cost of Equity * MV of Equity /MV of Enterprise + Cost of Preference * MV of Preference / MV of Enterprise

WACC = 4% * 2.7 / 7.7*(1-30%)+6.2%*4.5/7.7+5%*0.5/7.7 = 4.92%