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.

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%