Sapp Trucking\'s balance sheet shows a total of noncallable $45 million long-ter
ID: 2665713 • Letter: S
Question
Sapp Trucking's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%. This debt currently has a market value of $50 million. The balance sheet also shows that the company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between these two WACCs?a. 1.55%
b. 1.72%
c. 1.91%
d. 2.13%
e. 2.36%
Please show all work related to answer.
Explanation / Answer
Market value of Debt = $50 million
Market value of equity = $22.50 * 10 million shares =$225 million
Total market value = $225 + $50 = $275 million
Weight of Market value of debt = $50/$275 *100 = 18.18%
Weight of Market value of Equity= $225/$275 *100 = 81.82%
Book value of Debt = $45 million
Book value of Equity = $65 million
Total Book value = $45 + $65 = $110 million
Weight of Book value of debt = $45/$110 *100 = 40.91%
Weight of Book value of Equity= $65/$110 *100 = 59.09%
WACC= WdRd(1-t) + We*Re
Bond yield (rd) = 6%
tax rate = 40 %
Cost of equity (re) = 14%
WACC at Book value = .4091*6(1-.40)+.5909*14 = 9.75%
Difference between these two WACCs = 12.11% - 9.75% = 2.36%
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