Question

KD Corp. issued 7.6% semiannual-pay coupon bonds five years ago at par value. The bonds mature 10 years from today and are currently selling at $1,103.19. The beta for the KD Corp. common stock is 1.2. The firm has a target capital structure of 30% debt and 70% equity, but the actual weights reported on the firm's balance sheet are 45% debt and 55% equity. KD Corp has a 21% marginal tax rate. Assume the risk-free rate is 3% and the market risk premium is 7%. What is the weighted average cost of capital for KD Corp?

Select one:

a. 6.89%

b. 7.86%

c. 8.47%

d. 8.97%

e. 9.45%

Answer 1

e) 9.45%

Explanation:

Cost of equity= risk free rate + beta (market risk premium)

= 3% + 1.2 (7%)

= 3% + 8.4%

= 11.4%

Using financial calculator to calculate the cost of debt

Inputs: N= 10 × 2= 20 (semiannual compounding)

Pv= -1,103.19

Pmt= 7.6% / 2 × 1,000 = 38

Fv= 1,000

I/y= compute

We get, ytm of the bond as 3.1% × 2 = 6.2%

After tax cost of debt = ytm (1- tax rate)

= 6.2% (1 - 0.21)

= 6.2% (0.79)

= 4.898%

We use target weights, because that's what the company wants to achieve

WACC = weight of debt × after tax cost of debt + Weight of equity × cost of equity

= 0.30 × 4.898% + 0.7 × 11.4%

= 1.4694% + 7.98%

= 9.45%