A company\'s balance sheets show a total of $ 28 million long-term debt with a c

Question

A company's balance sheets show a total of $ 28 million long-term debt with a coupon rate of 10 percent. The yield to maturity on this debt is 8.55 percent, and the debt has a total current market value of $ 31 million. The balance sheets also show that that the company has 10 million shares of stock; the total of common stock and retained earnings is $30 million. The current stock price is $7.5 per share. The current return required by stockholders, rs, is 11 percent. The company has a target capital structure of 40 percent debt and 60 percent equity. The tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects? Express your answer in percentage (without the % sign) and round it to two decimal places.

Explanation / Answer

Cost of debt =Kd = 8.55 (1-.40)= 5.13%

Cost of equity=Ke =11%

WACC= W1*Kd + W2*Ke

WACC= .40*5.13 + .60*11

WACC= 2.052% + 6.60% = 8.652 %

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