Use the information below and market values to find this company’s WACC. • The r

Question

Use the information below and market values to find this company’s WACC. • The risk-free rate is 4%. The expected return on the market is 12.5%. • The company’s beta is 1.8. • The company has three different bond issues outstanding: o Bond 1 is a zero-coupon bond with YTM of 7%, face value of $1,000, and it matures in 8 years. There are 50,000 of these bonds outstanding. o Bond 2 is a 5% coupon bond with YTM of 3.5%, face value of $1,000, and it matures in 12 years. There are 75,000 of these bonds outstanding. o Bond 3 is a an unconventional bond that pays no coupon for the next four years, then pays a 10% coupon for the remaining 3 years of its lifetime. Face value is $1,000. The YTM on these bonds is 9%. There are 100,000 of these bonds outstanding. • The company’s current stock price is $42. There are 6,000,000 shares of stock outstanding. • The company’s average tax rate is 30%.

Explanation / Answer

Calulation of WACC Note 1 Calculation of Ke i.e. Cost of equity Ke = Risk Free Return + Beta(Market Return - Risf free Return)       = 4% + 1.8(12.5%-4%)       =19.3% Note 2 Calculation of Kd i.e. Cost of debt Kd = YTM (I-tax rate) Bond 1 = 7%(1-30%)              =4.9% Bond 2 = 3.5%(1-30%)               =2.45% Bond 3=9% (1-30%)             =6.3% Type of Security Quantity Rate Value Weight Cost of Capital Weighted Cost Shares 6000000 42 252000000 0.53 19.30% 10.20% Bond1 50000 1000 50000000 0.10 4.90% 0.51% Bond2 75000 1000 75000000 0.16 2.45% 0.39% Bond3 100000 1000 100000000 0.21 6.30% 1.32% Total 477000000 WACC 12.42%

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