A company balance sheets show a total of $30 million long-term debt with a coupo

Question

A company balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 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 12 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?

Explanation / Answer

Cost of debt =Kd = 11.11(1-.40)= 6.67% Cost of equity=Ke =12% WACC= W1*Kd + W2*Ke WACC= .40*6.67 + .60*12 WACC= 2.67% + 7.2% = 9.87%

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