Question

To estimate the company's WACC, Marshall Inc. recently hired you as a consultant. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00. (2) The company's tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares. What is its WACC?

Answer 1

Solution :

Here, We need to calculate the Before tax cost of debt by using RATE function in Excel as follows :

Before tax cost of debt =RATE(nper,pmt,pv,fv)

=RATE(20*2,80/2,-1050,1000) * 2

= 7.51%

Now,

After tax cost of debt = Before tax cost of debt * ( 1 - tax rate )

= 7.51% * ( 1 - 0.40 )

= 4.51%

Then,

Cost of equity = Risk free rate + beta * market premium

= 0.045 + ( 1.20 * 0.055 )

= 11.10%

Finally,

WACC :

Particulars	Weight	Cost	Weighted cost
Equity	0.65	11.10%	0.07215
Debt	0.35	4.51$	0.01578
		WACC =>	8.79%