Question

The Paulson Company's year-end balance sheet is shown below. Its cost of common equity is 16%, its before-tax cost of debt is 12%, and its marginal tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,184. The firm has 576 shares of common stock outstanding that sell for $4.00 per share.

Assets Liability/Equity

Cash $ 120 Accts. Payable/ Accurals $10

Acct.Rec. $ 240 Short Term Debt $44

Inventory   $360 Long Term Debt $1140

Plant & Eq. $2160 Common Equity $1686

Total Assets..$2880 Total Liabilities/Equity $2880

Calculate Paulson's WACC using market-value weights. Do not round intermediate calculations. Round answer to two decimal places.

Answer 1

Answer:
Market Value of Debt = $1,140
Market Value of Equity = 576 * $4.00 = $2,304
Total value of firm = $1,140 + $2,304
Total value of firm = $3,444

Weight of Debt = $1,140 / $3,444
Weight of Debt = 0.3310

Weight of Equity = $2,304 / $3,444
Weight of Equity = 0.6690

Before Tax Cost of Debt = 12%
After Tax Cost of Debt = 12% * (1 – 0.40)
After Tax Cost of Debt = 7.20%

Cost of Equity = 16%

WACC = (Weight of Debt * After Tax Cost of Debt) + (Weight of Equity * Cost of Equity)
WACC = (0.3310 * 7.20%) + (0.6690 * 16%)
WACC = 13.09%