Question

13. A company has $400 million worth of debt outstanding with an average interest rate of 5% and 50 million common shares outstanding worth $12 each. The company’s tax rate is 28%, beta is 1.2, the yield on 10-year Treasury notes is 1.5% and the expected market return is 9.5%. What is the company’s weighted average cost of capital (WACC) based on the current weights for debt and common stock in its capital structure?

Need help. Any help would be greatly appreciated.

Answer 1

Cost of equity = Risk-free rate + Beta(Market return - Risk-free rate)

Cost of equity = 0.015 + 1.2(0.095 - 0.015)

Cost of equity = 0.111 or 11.1%

Common equity = 50 million * $12 = $600 million

Weight of common equity = $600 million / ($400 million + $600 million) = 0.60

Weight of debt = $400 million / ($400 million + $600 million) = 0.40

WACC = (Weight of common stock * Cost of common equity) + [Weight of debt * Pretax cost of debt(1 - Tax)]

WACC = (0.60 * 0.111) + [0.40 * 0.05(1 - 0.28)]

WACC = 0.081 or 8.1%