Question

Badger Corp. has an issue of 6% bonds outstanding with 6 months left to maturity. The bonds are currently priced at $1,014.79, and pay interest semiannually. The firm's marginal tax rate is 40%. The estimated risk premium between the company's stock and bond returns is 3%. The firm's expects to maintain a capital structure with 40% debt and 60% equity going forward. The company's W.A.C.C. is ____%. Round your final answer to 2 decimal places (example: enter 12.34 for 12.34%), but do not round any intermediate work in the process.

Margin of error for correct responses: +/- .05.

Answer 1

Given about Badger Corp,

6% bonds outstanding with 6 months left to maturity

current price of bond = $1014.79

Face value = $1000

Coupon = (6%/2) of 1000 = $30

So, money received after 6 months = FV + coupon = $1030

return on bond = FV/PV - 1 = 1030/1014.79 - 1 = 1.50%

So, annual rate of return on bond = 2*1.50 = 3%

=> cost of debt Kd = YTM of the bond = 3%

It is given that, the estimated risk premium between the company's stock and bond returns is 3%

So, return on stock = return on bond + risk premium = 3 + 3 = 6%

=> cost of equity Ke = 6%

The firm's expects to maintain a capital structure with 40% debt and 60% equity going forward.

So, Weight of debt Wd = 40%

Weight of equity We = 60%

tax rate T = 40%

So, WACC = Wd*Kd*(1-T) + We*Ke = 0.6*3*(1-0.4) + 0.4*6 = 3.50%

So, WACC of the company is 3.50%