You have obtained the following information: (1) The company has noncallable bon

Question

You have obtained the following information:

(1) The company has noncallable bonds which mature in 25 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,075.00.

(2) The company%u2019s tax rate is 40%.

(3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock%u2019s beta is 1.20.

(4) The target capital structure consists of 35% debt and the balance as common equity. The company uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock.

Given the information you have obtained, what is its WACC?

Explanation / Answer

Target Capital Structure:

Equity (wc ) - 65% (0.65)

Debt (wd ) - 35%(0.35)

Calculating Weighted Average Cost of Capital(WACC):

WACC= wd kd (1-T) + wc ks

WACC = (0.35*0.04404) + (0.65 * 0.111 )

= 0.015414 + 0.07215

= 0.087564 (or) 8.76%%

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