Bolster Foods’ (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, rs, is 12.00%. The company recently decided that its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on book, market, and target capital structures, and then find the sum of these three WACCs. a. 26.60% b. 36.27% c. 30.22% d. 27.81% e. 24.78%
Solution:-
Ans:- c) 30.22%
Calculations:-
WACC= Cost of debt*(1-tax)*weight of debt+ Cost of equity*weight of debt
Cost of debt = 8.00%
Cost of equity= 12.00%
a)WACC based on book value
Book value of debt = $25 million
Book value of equity = 10million*$5.00/share = $50 million
Now,
WACC= 8.00%*(1-0.40)*25/75+12%*50/75 =1.6%+8%=9.6%
b)WACC based on market value
Market value of debt = 27 million
Market value of equity = 10 million*$20/share =200 million
WACC= 8.00%*(1-0.40)*27/227+12%*200/227=0.5709%+10.57268%
=11.14%
c) WACC based on target capital structure.
Weight of debt = 35%
Weight of equity= 65%
WACC= 8.00%*(1-0.40)*0.35+12%*0.65 =1.68%+7.8%=9.48%
Sum of all three WACC= 9.6%+11.14%+9.48%= 30.22%
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