Question

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 ?

Answer 1

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%