WACC 2 The current stock price for a company is $33 per share, and there are 4 m

ID: 2769479 • Letter: W

Question

WACC 2

The current stock price for a company is $33 per share, and there are 4 million shares outstanding. The beta for this firms stock is 1.1, the risk-free rate is 4.9, and the expected market risk premium is 5.8%. This firm also has 80,000 bonds outstanding, which pay interest semiannually. These bonds have a coupon interest rate of 9%, 10 years to maturity, a face value of $1,000, and an annual yield to maturity of 6.3%. If the corporate tax rate is 37%, what is the Weighted Average Cost of Capital (WACC) for this firm?

The correct answer is 8.20. Show step by step how I arrive at this answer.

Explanation / Answer

Answer:

Cost of Equity as per CAPM method = Risk Free Return + Beta x Market Risk Premium

= 4.9% + 1.1 x 5.8%

= 4.9% + 6.38%

= 11.28%

Cost of Debt after tax = Yied to maturity x (1 - Tax Rate)

= 6.3% (1 - 0.37)

= 3.969%

Calculation of Current Value of the bonds

Semi Annual Coupon Interest = $1,000*9%*1/2 = $45

Yield to Maturity = 6.3% annual or 3.15% semi annually

No.of coupon interest to be made = 10 years x 2 = 20 times

Current Value of the bonds = Semi Annual Coupon Interest x PVIFA (3.15%, 20) + Par Value x PVIF (3.15%, 20)

= ($45 x 14.673) + ($1,000 x 0.53779)

= $660.285 + $537.79

= $1,198.08

Total Market Value of the bonds = 80,000 bonds x $1,198.08 = $95,846,400

Calculation of WACC of the firm at market value weight

Capital Structure

Market Value

Market Weight

Cost of Capital

WACC

Common Stock (33*4,000,000)

$132,000,000

132,000,000 / 227,846,400 = 0.58

11.28

6.53

Bonds

$95,846,400

95,846,400 / 227,846,400 = 0.42

3.97

1.67

$227,846,400

8.20

WACC at market weight = 8.20%