Question

1. Bob's firm is a retail chain of specialty hardware stores. The firm has 21,000 shares of stock outstanding that are currently valued at $68 a share and provide a 13.2% rate of return. The firm also has 500 coupon bonds outstanding that have a face value of $1,000, a market price of $1,068, mature in 6 years and have a YTM of 5.648%. The tax rate is 35%.

Compute cost of debt

Compute cost of equity

Compute WACC

PLEASE SOLVE ALEGEBRAICALLY AND SHOW ALL STEPS

Answer 1

Answer 1:

Cost of debt = YTM of Bonds = 5.648%

Answer 2:

Cost of Equity = Rate of return on shares = 13.20%

Answer 3:

Capital structure:

Market value of equity = Number of shares of stock outstanding * share price = 21000 * $68 = $1,428,000

Market value of debt = Number of bond outstanding * Price of bond = 500 * $1068 = $534,000

Total value = 1428000 + 534000 = $1,962,000

WACC:

WACC = Cost of Equity * Weight of Equity + Cost of Debt * (1 - Tax rate) * Weight of debt

= 13.20% * 1428000 / 1962000 + 5.648% * (1 - 35%) * 534000 / 1962000

= 10.61%

WACC = 10.61%