Question

Wagon Corporation is considering a new investment project and needs to determine WACC as a reference to project’s discount rate. Currently, company has 1,000 corporate bonds and 200,000 ordinary shares outstanding. Market price of the share is $20 while corporate bonds have 10 -year maturity, interest rate of 9% paid semi-annually, face value of $1,000 and required rate of return of 10%. Tax rate is 30%. Beta coefficient of the ordinary share is 0.95,risk free rate is 4% and market portfolio return is 15%. Calculate Wage’s WAC

Answer 1

Debt: Face Value = $ 1000, Required Return = 10 % per annum or (10/2) = 5 % per half-year, Interest Rate = 9 % per annum or (9/2) = 4.5 % per half-year,Tenure = 10 years or (10 x 2) = 20 half-years

Semi-Annual Coupon = 0.09 x 1000 x 0.5 = $ 45

Bond Price = 45 x (1/0.05) x [1-{1/(1.05)^(20)}] + 1000 / (1.05)^(20) = $ 937.689 ~ $ 937.69

Number of Bonds = 1000, Debt value = 1000 x 937.69 = $ 937688.94 ~ $ 937689

Cost of Debt = kd = Required Return = 10 %

Equity: Number of Ordinary Shares = 200000 and Price per Share = $ 20, Equity Value = 20 x 200000 = $ 4000000

Beta Coefficient = 0.95, Risk-Free Rate = Rf = 4 % and Market Return = Rm = 15 %

Cost of Equity = ke = Rf + Beta x (Rm -Rf) = 4 + 0.95 x (15-4) = 14.45 %

Tax Rate = t = 30 %

WACC = (1-0.3) x 10 x [937689/(4000000 + 937689)] + 4.45 x [4000000/(4000000+937689)] = 13.0352 % ~ 13.03 %