Jack\'s Construction Co. has 100,000 bonds outstanding that are selling at par v

Question

Jack's Construction Co. has 100,000 bonds outstanding that are selling at par value. The bonds yield 10.3 percent. The company also has 4.8 million shares of common stock outstanding. The stock has a beta of 1.5 and sells for $60 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?

12.77 percent

6.25 percent

10.76 percent

9.04 percent

12.49 percent

Jack's Construction Co. has 100,000 bonds outstanding that are selling at par value. The bonds yield 10.3 percent. The company also has 4.8 million shares of common stock outstanding. The stock has a beta of 1.5 and sells for $60 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

Step 1:

1) Cost of Common Stock = Rf + (Rm-Rf)*Beta

Cost of Common Stock = 4 + 7*1.5

Cost of Common Stock = 14.5%

2)

After Tax Cost of Debt = 10.3*(1-35%)

After Tax Cost of Debt = 6.695%

Step 2:

Market Value of Common Stock = 4800000*60 = $ 288 Million

Market Value of Bond = 100000 *1000 = $ 100 Million

Total Market Value = 388 Million

Weight of Common Stock = 288/388

Weight of Debt = 100/388

Step3:

WACC = Weight of Common Stock* Cost of Common Stock + Weight of Debt* After Tax cost of Debt

WACC = 288/388*14.5 + 100/388*6.695

WACC = 12.49%

Answer

12.49 percent

Related Questions

Navigate

• Browse (All)
• Browse J
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.