Also, what is the adjusted WACC of Thorpe and Company after the bond sale if the

Question

Also, what is the adjusted WACC of Thorpe and Company after the bond sale if the corporate tax rate is 40%?

Adjusted WACC. Thorpe and Company is currently an all-equity firm. It has three million shares selling for $25 per share. Its beta is 1.2, and the current risk-free rate is 3.4%. The expected return on the market for the coming year is 13.1%. Thorpe will sell corporate bonds for $25,000,000 and retire common stock with the proceeds. The bonds are twenty-year semiannual bonds with a 10.8% coupon rate and $1,000 par value. The bonds are currently selling for S938.27 per bond. When the bonds are sold, the beta of the company will increase to 1.4. What was the WACC of Thorpe and Company before the bond sale? What is the adjusted WACC of Thorpe and Company after the bond sale if the corporate tax rate is 40%? Hint: The weight of equity before selling the bond is 100%. What was the WACC of Thorpe and Company before the bond sale? (Round to two decimal places.)

Explanation / Answer

The WACC before bond sale would be equal to cost of equity as there is no debt in the capital structure.

We can calculate cost of equity using the following formula:

Ke = Rf + (Rm- Rf) x beta

     = 0.034 + (0.1310 – 0.034) x 1.20

     = 0.034 + 0.1164

     = 15.04%

Therefore, WACC before bond sale would be 15.04%.

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