Question

[USE THIS INFORMATION FOR ALL 5 QUESTIONS] Suppose a firm has 38 million shares of common stock outstanding at a price of $24.5 per share. The firm also has 100,000 bonds outstanding with a current price of $1075.7. The outstanding bonds have yield to maturity 8.7%. The firm's common stock beta is 0.8 and the corporate tax rate is 38%. The expected market return is 11% and the T-bill rate is 1%.

a. What is the weight of equity used in the WACC for this firm? (Show your answer to 3 decimals.)

b. What is the weight of debt used in the WACC for this firm? (Show your answer to 3 decimals.)

c. Cost of equity (4 decimal places)?

d. After tax cost of debt? (4 decimal places)

e. What is the weighted average cost of capital (WACC)? (4 decimals)

Answer 1

Value of equity = shares * market price per share

= 38 million * $ 24.5

= $ 931 Million

Value of bond = 100000*$1075.7

= $ 107.57 million

Total Value = Value of bond + Value of Equity

= $ 931 Million + 107.57 million

=$ 1038.57 Million

a.Weight of  equity used in the WACC for this firm = 931/1038.57

= 89.642%

b. weight of debt = 107.57/1038.57

= 10.358%

c. Cost of equity =risk free rate + (expected market return -risk free rate)*beta

= 1%+(11%-1%)*0.8

= 9.0000%

d. After tax cost of debt =  yield to maturity  *(1-  tax rate )

= 8.7%*(1- 38%)

= 5.394%

e. weighted average cost of capital (WACC) =  (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

= (10.358%*5.394%)+(89.642%*9%)

= 8.6265%