2. Bilee Company%u2019s financial manager, Mr. STEPHENS, has collected the follo

Question

2. Bilee Company%u2019s financial manager, Mr. STEPHENS, has collected the following information to calculate its WACC:

%u2022 Wilee%u2019s capital structure consists of 40% debt and 60% common stock.

%u2022 Wilee has 25-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,252.

%u2022 Wilee uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 5% and the market risk premium is 6%. Wilee%u2019s common stock has a beta of 1.6. Wilee%u2019s tax rate is 40%.(7 points)

a. What is the company%u2019s after-tax cost of debt?

b. What is the company%u2019s cost of common equity?

c. What is the company%u2019s weighted average cost of capital (WACC)

Explanation / Answer

Hi,

Please find the answers as follows:

1)

D1 = 1*(1+.20) = 1.20

D2 = 1.20*(1+.15) = 1.38

P2 = 1.38*(1+.05)/(.12 - .05) = 20.7

Current Stock Price = 1.20/(1+.12)^1 + (1.38 + 20.7)/(1+.12)^2 = 18.67

Answer is 18.67

2)

After Tax Cost of Debt =

Nper = 25

Payment = 1000*.12 = 120

PV = -1252

FV = 1000

Rate = Rate(25, 120, -1252, 1000) = 9.36%

After Tax Cost of Debt = 9.36*(1-.40) = 5.62%

Cost of Equity = 5 + 1.6*(6) = 14.6%

WACC = .40*5.62 + .60*14.6 = 11.008 or 11%

Thanks.

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