QUESTION 40 The current stock price for a company is $49 per share, and there ar

Question

QUESTION 40 The current stock price for a company is $49 per share, and there are 3 million shares outstanding. The beta for this firms stock is 1.4, the risk-free rate is 4.1, and the expected market risk premium is 6.2%. This firm also has 260,000 bonds outstanding, which pay interest semiannually. These bonds have a coupon interest rate of 10%, 23 years to maturity, a face value of $1,000, and a current price of 989.05. If the corporate tax rate is 36%, what is the Weighted Average Cost of Capital (WACC) for this firm? (Answer to the nearest hundredth of a percent, but do not use a percent sign).

Explanation / Answer

Cost of debt will be after tax YTM of the bond:

YTM of the bond:
Bond Value = C/2 {[1-(1+(YTM/2))-2t/(YTM/2)] + [F / (1+ (YTM/2))2t]

B0 = $989.05
C = $1,000 x 10% = $100
F = $1,000
YTM = the yield to maturity on the bond
t = 23

$989.05 = $100/2 {[1-(1+(YTM/2))-46/(YTM/2)] + [$1,000 / (1+ (YTM/2))46] = 10.12%

After tax YTM = 10.12% x (1-tax) = 10.12% x 0.64 = 6.4768%

Cost of Equity:

4.1% + 1.4*(6.2%) = 12.78%

Total Capital = ($49 x 3,000,000) + ($989.05 x 260,000) = $404,153,000

WACC = {[($49 x 3,000,000)/ $404,153,000] x 12.78%} + {[($989.05 x 260,000)/ $404,153,000] x 6.4768%} = 8.7694%

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