Data Inc. recently hired you as a consultant to evaluate its cost of capital. Us
ID: 2716779 • Letter: D
Question
Data Inc. recently hired you as a consultant to evaluate its cost of capital. Using the following information, determine Data Inc’s cost of capital. New debt can be raised at a rate equal to the yield to maturity (YTM) on the company’s outstanding bonds. Their outstanding bonds mature in 20 years, have an 8% annual coupon, a par value of $1,000 and a market price of $1,050.00.
The company’s tax rate is 40%.
The risk-free rate is 4.50%, the market risk premium is 5.50% and the stock’s beta is 1.20.
The target capital structure consists of 35% debt and no preferred stock.
Explanation / Answer
Step 1:
1) Cost of Common Stock = Rf + (Rm-Rf)*Beta
Cost of Common Stock = 4.5 + 5.5*1.2
Cost of Common Stock = 11.1%
2) Before Tax Cost of Debt = rate(nper,pmt,pv,fv)
Before Tax Cost of Debt = rate(20,80,-1050,1000)
Before Tax Cost of Debt = 7.51 %
After Tax Cost of Debt = Before Tax Cost of Debt *(1-tax rate)
After Tax Cost of Debt =7.51*(1-40%)
After Tax Cost of Debt = 4.51%
Step 2:
Weight of Common Stock = (1-35%) = 65%
Weight of Debt = 35%
Step3:
WACC = Weight of Common Stock* Cost of Common Stock + Weight of Debt* After Tax cost of Debt
WACC = 65%*11.1 + 35%*4.51
WACC = 8.79%
Answer
Data Inc’s cost of capital = 8.79%
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