Question

# A us based company has a market value of its debt equal to \$40 million and...

A us based company has a market value of its debt equal to \$40 million and has 3 million outstanding shares of stock , each selling for \$20 per share. The company pays a 5% rate of interest on its debt and has a beta of 1.41. The corporate tax rate is 34%. The risk premium on the market is 9.5%. the current treasury bill rate is 1%. What is the firm’s weighted average cost of capital?

Ans : Weighted Average Cost of Capital

WACC = (Cost of Equity * Equity Proportion) + (Cost of Debt after tax * Debt Proportion)

1) Debt/Equity Proportion

Total Capital = Total Debt + Total Equity
= \$40 million + (3 million shares * \$20 per share)
= \$40 million + \$60 million
= \$100 milion

Debt Proportion
= Debt / Total Capital = \$40 million / \$100 million = 0.4
Equity Proportion
= Equity / Total Capital = \$60 million / \$100 million = 0.6

2) Cost of Equity/Debt

Cost of Debt after tax
= Cost of Debt * (1-tax rate)
= 5% * (1-34%)
= 3.3%

Cost of Equity = Risk Free Rate + (Beta * Market Risk Premium)
= 1% + ( 1.41 * 9.5%)
= 1% + 13.395%
= 14.395%

WACC = (Cost of Equity * Equity Proportion) + (Cost of Debt after tax * Debt Proportion)
= (14.395% * 0.6) + (3.3% * 0.4)
= 8.637% + 1.32%
= 9.957%

Ans : The firm's weighted average cost of capital is 9.957%