Question

Common Stock information Bond Information Beta of 0.98 Market risk premium 7.6% Risk-free rate 3.9% Par...

Common Stock information

Bond Information

  • Beta of 0.98

  • Market risk premium 7.6%

  • Risk-free rate 3.9%

  • Par value $1,000

  • Current Price $1,016

  • Bond matures in 8 years

  • Annual coupon interest payment $90

The market value of John’s stock represents 50% of the external financing, and bonds represent the other 50%. John’s tax rate is 0%, so after-tax cost of debt = before-tax cost of debt (therefore, no adjustment needed for tax).

Calculate John’s weighted average cost of capital.

Homework Answers

Answer #1

Cost of equity = Risk free rate of return + beta(Market risk premium)
=3.9% + 0.98(7.6%)
=3.9% + 7.45%
= 11.35%

Cost of debt = YTM = Interest +(Face value -current market price/n) / (Face value + current market price/2)
Interest = $90
Par value = $1000
Current price = $1016
n = no of year till maturity = 8
Thus cost of debt = 90 +(1000-1016/8) / (1000+1016)/2
=90+(-16/8) / 2016/2
= 90 - 2 / 1008
= 88 /1008
= 0.0873
i.e 8.73%

Statement showing WACC

Particulars Weight Cost of capital WACC
a b c =axb
Equity 50% 11.35% 5.68%
Debt 50% 8.73% 4.37%
WACC 10.04%

Thus WACC = 10.04%

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