Question

Xaomin Inc. tries to determine their cost of capital. The long-term debt it has is a 15-year bond, 12% coupon, $1,000 par value, selling at $1,060. They have $24,500 in debt and $45,500 equity. Their estimated cost of equity is 14%. Tax rate is 21%.

What is Xaomin's cost of capital?

Question 3 options:

	15.44%
	17.53%
	12.19%
	8.69%

Answer 1

Given about Xaomin Inc.'s bond,

Year to maturity = 15 year

coupon rate = 12%

Face value = $1000

Coupon = 12% of 1000 = $120

Price of the bond = $1060

So, calculating YTM of the bond using financial calculator, use following values:

FV = 1000

PV = -1060

PMT = 120

N = 15

compute for I/Y, we get I/Y = 11.16

So, yield to maturity of the bond = 11.16%

Foe a company, YTM of its bond is equal to cost of debt of the bond.

Cost of debt of the company Kd = 11.16%

cost of equity Ke = 14%

Total debt of company = $24500

total equity of company = $45500

Weight of debt = Debt/(debt+equity) = 24500/(24500+45500) = 0.35

similarly, weight of equity = equity/(debt + equity) = 45500/(24500+45500) = 0.65

So, WACC of Xaomin Inc is

WACC = Wd*Kd*(1-T) + We*Ke = 0.35*11.16*(1-0.21) + 0.65*14 = 12.19%

So, option C is correct.