LeeBurly Corporation ’s financial manager , Mr. George Peltay, has collected the

Question

LeeBurly Corporation ’s financial manager , Mr. George Peltay, has collected the following information to calculate its WACC:

• LeeBurly’s capital structure consists of 40% debt and 60% common stock.
• LeeBurly has 25-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,252.
• LeeBurly uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 5% and the market risk premium is 6%. LeeBurly’s common stock has a beta of 1.6. LeeBurly’s tax rate is 40%.(7 points)

What is the company’s weighted average cost of capital (WACC)?

Explanation / Answer

      

According to the given information,

Computing the Cost of equity using CAPM:

According to CAPM,

                     Cost of equity (Re) = Rf + Beta [Rm - Rf]

Substituting the values in the above equation, we get

Therefore, the cost of equity is 14.6%

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Calculating the WACC:

           

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