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