Question

A company has equity beta 0.8 and market value of equity $350 million. The yield to maturity on this company’s debt is 8.4%. The market value of that debt is $250 million. The risk-free rate is 4% and the expected return on the market is 12%; the tax rate of this company is 40%. What is the WACC?

Answer 1

The WACC is computed as shown below:

= cost of debt (1 - tax rate) x weight of debt + cost of equity x weight of equity

cost of equity is computed as follows:

= risk free rate + beta x (return on market - risk free rate)

= 4% + 0.8 x (0.12 - 0.04)

= 10.4% or 0.104

So, the WACC will be as follows:

= 0.084 x (1 - 0.40) x $ 250 million / ($ 250 million + 350 million) + 0.104 x $ 350 million / ($ 250 million + 350 million)

= 0.0504 x $ 250 million / $ 600 million + 0.104 x $ 350 million / $ 600 million

= 8.17% Approximately

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