Question

# An analyst is trying to determine the capital structure for Big Dawg Incorporated. After some careful...

An analyst is trying to determine the capital structure for Big Dawg Incorporated. After some careful research, the analyst knows the following --Big Dawg has 1.60 million shares of common stock trading today at \$19.00 per share. The book value of Big Dawg common stock is \$15.00 million . The cost of equity for the firm is estimated to be 12.00 %. --Big Dawg has \$12.00 million in long-term debt on its balance sheet . The debt is trading at 92.00 % of face value in the market with a yield to maturity of 9.00 %. The tax rate facing the firm is 39.00 %. What is the weighted average cost of capital for Big Dawg ?

Solution :

Market value of equity (E)= value per share * No.of shares

= \$ 19 * 1.6mn

= \$ 30.4mn

Market value of debt (D)=\$ 12mn * 92%

= \$ 11.04 mn

Total market value of debt & equity (V)

=\$ 11.04mn +\$ 30.4mn

= \$ 41.44mn

Cost of debt i.e YTM (Kd) = 9%

Cost of equity (Ke) = 12%

Tax rate(t) = 0.39

So,

WACC = (Ke * E/V) + [Kd*(1-t)* D/V]

= (0.12 * 30.4/41.44) + [0.09* (1-0.39)* 11.04/41.44]

= (0.12* 0.7336) + (0.09 * 0.61 * 0.2664)

= 0.0880 + 0.0146

=0.1026 i.e 10.26%

Or

If we calculate WACC using Book value weights then,

WACC= (Ke * BV of equity/BV of equity & debt) +

[Kd * (1-t) * BV of debt/BV of equity & debt]

= (0.12 * 15/27) + [(0.09 * (1-0.39) * 12/27]

=(0.12 * 0.5555) + (0.0549 * 0.4444)

= 0.0666 + 0.0243

= 0.0909 i.e 9.09%

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