Question

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 20%, 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?

Answer #1

WACC = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

= 8.26%

Answer = **8.26%**

Note:

1.

After tax cost of debt = Interest Rate * (1-Tax Rate)

= 5%*(1-20%)

= 4.00%

Cost of Equity = risk free rate + (market return - risk free rate )* beta

= 1.5%+(9.5%-1.5%)*1.2

= 11.10%

2. Value of Debt = $ 400 Million

Value of Equity = 50 Million Shares * $ 12

= $ 600 Million

3. Computation of WACC

Value | Weight ( market value / total) | Cost | Weight *cost | |

Debt | 400.00 | 0.40 | 4.00% | 1.60 |

Equity | 600.00 | 0.60 | 11.10% | 6.66 |

Total | 1,000.00 | WACC | 8.26 |

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