Question

Here is some information about Stokenchurch Inc.: Beta of common stock = 1.7 Treasury bill rate = 4% Market risk premium = 8.0% Yield to maturity on long-term debt = 9% Book value of equity = $490 million Market value of equity = $980 million Long-term debt outstanding = $980 million Corporate tax rate = 21% What is the company’s WACC?

Answer 1

The WACC is computed as shown below:

= cost of equity x weight of equity + cost of debt (1 - tax rate) x weight of debt

cost of equity is computed as follows:

= treasury bill rate + beta x market risk premium

= 0.04 + 1.7 x 0.08

= 17.6% or 0.176

So, the WACC will be as follows:

= 0.176 x $ 980 million / ( $ 980 million + $ 980 million) + 0.09 x (1 - 0.21) x $ 980 million / ( $ 980 million + $ 980 million)

= 12.355%

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