a.ABC Inc. has borrowed $60 million in loans, issued $90 million in bonds, and i
ID: 1216941 • Letter: A
Question
a.ABC Inc. has borrowed $60 million in loans, issued $90 million in bonds, and issues $150 million in common stocks. Flag this Question Question 1 1 pts If they used 6.0% ROR for loans, 7.0% ROR for bonds, and 13.0% ROR for stocks, what is the Weighted Average Cost of Capital (WACC)?
b. If the same company used 8.0% ROR for loans, 9.0% ROR for bonds, and 15.0% ROR for stocks, and also used a 50% tax rate, what is the WACC?
Enter the answer as a percentage. For example 12.34% is 12.34. Keep 2 decimal places and do not enter the % symbol.
Hint: Remember that the stocks and retained earnings are not taxable.
Explanation / Answer
(a) ABC Inc's equity (E) = $150 million
Value of loan (L) taken by ABC Inc = $60 million
Value of bonds (B) issued by ABC Inc = $90 million
Total Market value of ABC Inc (V) = E + L + B = $150 million + $60 million + $90 million = $300 million
Return on equity (Re) = 13% or 0.13
Return on loans (Rl) = 6% or 0.06
Return on Bonds (Rb) = 7% or 0.07
In the given case no tax rate is given so tax rate will be 0%.
Calculate Weighted Average Cost of Capital (WACC) -
WACC = ((E/V) * Re) + (((B/V) * Rb) * (1-T)) + (((L/V) * Rl) * (1-T))
WACC = (($150 million/$300 million) * 0.13) + (($90 million/$300 million) * 0.07) * (1-0)) + (($60 million/$300 million) * 0.06) * (1-0))
WACC = 0.065 + 0.021 + 0.012
WACC = 0.098 or 9.8%
The WACC is 9.8%.
(b) ABC Inc's equity (E) = $150 million
Value of loan (L) taken by ABC Inc = $60 million
Value of bonds (B) issued by ABC Inc = $90 million
Total Market value of ABC Inc (V) = E + L + B = $150 million + $60 million + $90 million = $300 million
Return on equity (Re) = 15% or 0.15
Return on loans (Rl) = 8% or 0.08
Return on Bonds (Rb) = 9% or 0.09
In the given case tax rate is 50% or 0.50
Calculate Weighted Average Cost of Capital (WACC) -
WACC = ((E/V) * Re) + (((B/V) * Rb) * (1-T)) + (((L/V) * Rl) * (1-T))
WACC = (($150 million/$300 million) * 0.15) + (($90 million/$300 million) * 0.09) * (1-0.50)) + (($60 million/$300 million) * 0.08) * (1-0.50))
WACC = 0.075 + 0.0135 + 0.008
WACC = 0.0965 or 9.65%
The WACC is 9.65%.
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