Question

2. Here is some information about Stokenchurch Inc.:

Beta of common stock = 2.1
Treasury bill rate = 4%
Market risk premium = 8.4%
Yield to maturity on long-term debt = 7% Book value of equity = $530 million
Market value of equity = $1,060 million Long-term debt outstanding = $1,060 million Corporate tax rate = 35%

What is the company’s WACC?

Answer 1

Market Value of Debt and Equity

Market Value of Debt = $1,060 Million

Market Value of Equity = $1,060 Million

Total Market Value = $2,120 Million

Weight of Capital Structure

Weight of Debt = 0.50 [$1,060 Million / $2,120 Million]

Weight of Equity = 0.50 [$1,060 Million / $2,120 Million]

After-tax Cost of Debt

After Tax Cost of Debt = Pre-tax Cost of Debt x (1 – Tax Rate)

= 7.00% x (1 – 0.35)

= 7.00% x 0.65

= 4.55%

Cost of Equity

Cost of Equity = Risk-free Rate + [Beta x Market Risk Premium]

= 4.00% + [2.10 x 8.40%]

= 4.00% + 17.64%

= 21.64%

Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]

= [4.55% x 0.50] + [21.64% x 0.50]

= 2.28% + 10.82%

= 13.10%

“Therefore, the Company’s Weighted Average Cost of Capital (WACC) will be 13.10%”