Question

The Paulson Company's year-end balance sheet is shown below. Its cost of common equity is 14%, its before-tax cost of debt is 10%, and its marginal tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,116. The firm has 576 shares of common stock outstanding that sell for $4.00 per share.

Assets			Liabilities And Equity
Cash	$ 120		Accounts payable and accruals	$ 10
Accounts receivable	240		Short-term debt	46
Inventories	360		Long-term debt	1,070
Plant and equipment, net	2,160		Common equity	1,754
Total assets	$2,880		Total liabilities and equity	$2,880

Calculate Paulson's WACC using market-value weights. Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Md = Market Value of Debt = $1,116

Me = Market Value of Equity = 576 * $4 = $2,304

Wd = Weight of Debt = Md / (Md + Me) = $1,116 / ($1,116 + $2,304) = 0.32631579 = 0.32632

We = Weight of Equity = Me / (Md + Me) = $2,304 / ($1,1126 + $2,304) = 0.673684211 = 0.67368

rd = Cost of Debt = 10%

re = Cost of Equity = 14%

t = tax rate = 40%

WACC = [Wd * rd * (1- t)] + [We * re]

= [0.32632 * 10% * (1-40%)] + [0.67368 * 14%]

= 1.95792% + 9.43152%

= 11.38944%

Therefore, Paulson's WACC using market value weights is 11.39%