A firm has 1 million shares of common stock outstanding with a market price of $

Question

A firm has 1 million shares of common stock outstanding with a market price of $5.00 each. It has 2,500 bonds outstanding, each with a market value of $1,100. The bonds mature in 13 years, have a coupon rate of 10 percent, and pay coupons annually. The firm's beta is 1.3, the risk-free rate is 4.5 percent, the market risk premium is 7 percent, and the tax rate is 34 percent. What is the weighted average cost of capital (WACC)?

A)

5.45 percent

B)

6.53 percent

C)

9.49 percent

D)

10.81 percent

E)

11.65 percent

A firm has 1 million shares of common stock outstanding with a market price of $5.00 each. It has 2,500 bonds outstanding, each with a market value of $1,100. The bonds mature in 13 years, have a coupon rate of 10 percent, and pay coupons annually. The firm's beta is 1.3, the risk-free rate is 4.5 percent, the market risk premium is 7 percent, and the tax rate is 34 percent. What is the weighted average cost of capital (WACC)?

A)

5.45 percent

B)

6.53 percent

C)

9.49 percent

D)

10.81 percent

E)

11.65 percent

Explanation / Answer

Equity = 1m * 5 = $50,00,000

Debt = 2500*1000= $25,00,000

..

Weight of Equity (We)= 50/(50+25) = 0.67

Weight of Debt (Wd)= 25/(50+25) = 0.33

..

COst of Equity(Ke ) = Rf + (Rm-Rf)*Be

= 4.5 + 7*1

= 11.5%

Cost of Debt (Kd) = Not Given in the question

..

WACC = Ke*We + Kd*Wd

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