Question

# A company has \$400 million worth of debt outstanding with an average interest rate of 5%...

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?

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

= 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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