Question

A firm has 2,000,000 shares of common stock outstanding with a market price today of $3.00 each. It has 2,500 bonds outstanding, each with a market value today of $1,600 (160% of face). The bonds mature in 20 years, have a coupon rate of 10%, and pay coupons annually. The firm's beta is 1.4, the risk-free rate is 6%, and the market risk premium is 8%. The tax rate is 40%. Compute the WACC. (Hint, calculate: 1. weights, 2. after tax cost of debt, 3. cost of equity, 4. WACC). Do not use excel.

Answer 1

The market value of equity, E = 2,000,000 * 3 = $6,000,000

The market value of debt, d = 2,500 * 1,600 = $4,000,000

The weight of equity, We = 6,000,000/(6,000,000 + 4,000,000)

We = 0.60

The weight of debt, Wd = 4,000,000/(6,000,000 + 4,000,000)

Wd = 0.40

Cost of debt:

N = 20

FV = 1,000

PMT = 1,000 * 0.10 = 100

PV = -1,600

CPT I/Y

I/Y = 5.131583%

The cost of debt = 5.131583%

Cost of equity:

re = 0.06 + 1.4 * 0.08

re = 0.172

re = 17.2%