Question

- 50 million shares
- $80 per share
- Beta = 1.11
- Market risk premium = 7%
- Risk-free rate = 2%

Debt Information

- $1 billion in outstanding debt (face value)
- Current quote = 108
- Coupon rate = 9%, semiannual coupons
- 15 years to maturity
- Tax rate =35%

- What is the cost of equity? [K]

- What is the before-tax cost of debt? [L]

- What is the WACC?[M]

Answer #1

According to capm approach expected return on stock is risk free rate plus beta times market risk premium

= 2+1.1×7 = 9.7%

Cost of debt is yield to maturity of bonds

= (C+(PV-RV)/N)/(PV+RV)/2

where c is coupon

Pv is present value

Rv is redemption value

N is years to maturity

= (9+(100-108)/15)/(100+108)/2

= 8.14%

Before tax cost of debt is 8.14%

Tax rate is 35%

After tax cost of debt is 8.14(1-0.35)= 5.291%

Market value of shares is

0.5×80 = 40 billion

Market value of debt is 1.08 billion

Wacc= (40×9.7% + 1.08×5.291%)/41.08

= 9.58%

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