RON Ltd has the following capital structure components: Five million shares issu

Question

RON Ltd has the following capital structure components:

Five million shares issued with a current market price of 11. Equity holders require a 12% return.

$10 million face value of Corporate bonds outstanding. These bonds pay an annual coupon of 6% and currently trade at a yield to maturity of 6%.

If the firm faces a corporate tax rate of 30%, compute RON Ltd's Weighted Average Cost of Capital (WACC). Enter your answer in decimal form to FOUR decimal places. For example 10.34%, would be entered as 0.1034

Explanation / Answer

Ke = 12%

Kd = YTM(1-t) = 6%x(1-0.30)

                                = 4.20%

Amount of debt = 10 Million

Amount of equity = 11 x5 million = 55 million

Weight of debt = 10 million/ (10 million + 55 million)

                                = 0.15385

Weight of equity = 55 million/ (10 million + 55 million)

                                   = 0.84615

WACC= (Weight of debt x Kd + Weight of equity xKe)

                = (0.15385 x 4.20%   + 0.84615 x 12%)

                =10.80% or 0.1080

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