Question

Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital.

The balance sheet and some other information are provided below.

Assets Current assets $38,000,000

Net plant, property, and equipment $101,000,000

Total assets $139,000,000

Liabilities and Equity Accounts payable $10,000,000 Accruals $9,000,000

Current liabilities $19,000,000

Long-term debt (40,000 bonds, $1,000 par value) $40,000,000

Total liabilities $59,000,000 Common stock (10,000,000 shares) $30,000,000 Retained earnings $50,000,000

Total shareholders' equity $80,000,000

liabilities and shareholders' equity $139,000,000

The stock is currently selling for $17.75 per share, and its noncallable $3,319.97 par value, 20-year, 1.70% bonds with semiannual payments are selling for $881.00. The beta is 1.29, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%. Refer to Exhibit 10.1. What is the best estimate of the firm's WACC? Do not round your intermediate calculations. a. 12.59% b. 11.26% c. 12.11% d. 12.97% e. 11.74%

Answer 1

		Mrket value weight	As %	Cost	WACC
Bonds	(40000 bonds x $881)	35240000	16.56%	6.39%	0.010585
Shares	(10,000,000 shares x $17.75)	177500000	83.44%	13.24%	0.110468
		212740000			12.11%	Ans is C
Explanation:	Cost of equity, using CAPM
	Ke = Rf + Bx (Rmp)
	Ke = 5.5% + 1.29 x (11.5%-5.5%)
	Ke = 13.24%
	Cost of debt
	PV	881
	FV	3319.97
	NPER	40	(20 x 2)
	PMT	28.219745	(3319.97 x 1.7%/2)
	Rate	10.6425%
		=RATE(40,28.219745,-881,3319.97)*2
	After tax cost	6.39%	(10.6425% x (1-40%))