Kevin John Wright Express(KJWE) has a capital structure of 30% debt and 70% equi
ID: 2755644 • Letter: K
Question
Kevin John Wright Express(KJWE) has a capital structure of 30% debt and 70% equity. KJWE is considering a project that requires an investment of $2.6 million. To finance this project, KJWE plans to issue 10-year bonds with a coupon interest rate of 12%. Each of these bonds has a $1,000 face value and will be sold to net KJWE $980. If the current risk-free rate is 7% and the expected market return is 14.5%, what is the weighted cost of capital for KJWE? Assume the company has a beta of 1.20 and a marginal tax rate of 40%.
Explanation / Answer
WEIGHTED COST OF CAPITAL= WEIGHT * COST OF EQUITY(Ke) + WEIGHT * AFTER TAX COST OF DEBT Kd
COST OF EQUITY Ke= Rf + BETA(Rm - Rf)
Rf= RISK FREE RATE
Rm= MARKET RETURN
Ke= 7% + 1.2(14.5% - 7%)
=16%
AFTER TAX COST OF DEBT= Kd(1 - TAX RATE)
=12%(1 - 0.40)
=7.2%
WEIGHTED COST OF CAPITAL= 0.7 * 16% + 0.3 * 7.2%
=13.36%
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