3. (TCO E) Sapp Trucking\'s balance sheet shows a total of noncallable $45 milli
ID: 2694859 • Letter: 3
Question
3. (TCO E) 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%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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