Jack\'s Construction Co. has 100,000 bonds outstanding that are selling at par v
ID: 2634460 • Letter: J
Question
Jack's Construction Co. has 100,000 bonds outstanding that are selling at par value. The bonds yield 8.8 percent. The company also has 3.3 million shares of common stock outstanding. The stock has a beta of 1.4 and sells for $35 a share. The U.S. Treasury bill is yielding 4 percent and the market risk premium is 7 percent. Jack's tax rate is 35 percent. What is Jack's weighted average cost of capital?
Jack's Construction Co. has 100,000 bonds outstanding that are selling at par value. The bonds yield 8.8 percent. The company also has 3.3 million shares of common stock outstanding. The stock has a beta of 1.4 and sells for $35 a share. The U.S. Treasury bill is yielding 4 percent and the market risk premium is 7 percent. Jack's tax rate is 35 percent. What is Jack's weighted average cost of capital?
Explanation / Answer
Value of Debt = 100,000 x $1000 (Assuming the par value of bond to be $1,000) = $ 100,000,000
Value of Equity = 3,300,000 x $35 = $ 115,500,000
Total Debt and Equity = 215,500,000
Proportion of Debt = $100,000,000 / $215,500,000 = 46.40%
Proportion of Equity = $115,500,000 / $ 215,500,000 = 53.60%
Post tax cost of debt = I(1-t)
Kd = 8.8(1-0.35) = 5.72%
Ke = Rf +b(Risk premium)
Ke = 4 + 1.4(7) = 13.8%
WACC = 5.72(0.4640) + 13.80(0.536) = 10.05%
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