Question

What is your firm's Weighted Average Cost of Capital (input as a raw number, i.e. if your answer is 7.1%, enter 7.1)?

Corporate taxes are 21%. The firm is financed with the following securities:

• Common Equity:
  • 5,000,000 shares
  • price per share = $50
  • β=1.25, Mkt Risk Premium = 5%, Risk-free rate = 4%.
• Debt:
  • 200,000 bonds
  • face value per bond = $1000
  • market price per bond= $1075
  • coupon rate = 6%, 5 years to maturity (assume semi-annual payment.

Answer 1

Market value of common equity = 5,000,000 * 50 = 250,000,000

Market value of bond = 200,000 * 1,075 = 215,000,000

Total market value = 250,000,000 + 215,000,000 = 465,000,000

Cost of equity = Risk free rate + beta (market risk premium)

Cost of equity = 0.04 + 1.25 (0.05)

Cost of equity = 0.1025 or 10.25%

Coupon = (0.06 * 1000) / 2 = 30

Number of periods = 5 * 2 = 10

YTM = 4.3163%

Keys to use in a financial calculator: 2nd I/Y 2, FV 1000, PV -1075, N 10, PMT 30, CPT I/Y

WACC = Weight of debt*after tax cost of debt + weight of equity*cost of equity

WACC = (215,000,000 / 465,000,000)*0.043163*(1 - 0.21) + (250,000,000 / 465,000,000)*0.1025

WACC = 0.015766 + 0.05511

WACC = 0.071 or 7.1