Question

Assets Current assets $38,000,000 Net plant, property, and equipment $101,000,000 Total assets $139,000,000 Liabilities and Equity Accounts payable $10,000,000 Accruals $9,000,000 Current liabilities $19,000,000 Long-term debt (40,000 bonds, $1,000 par value) $40,000,000 Total liabilities $59,000,000 Common stock (10,000,000 shares) $30,000,000 Retained earnings $50,000,000 Total shareholders' equity $80,000,000 Total liabilities and shareholders' equity $139,000,000 The stock is currently selling for $15.00 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $1,150.00. The beta is 1.35, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%. What is the best estimate of the firm's WACC

Answer 1

Answer:

9.73%

Explanation:

the market value of equity = 10,000,000 stocks x $15 = $150,000,000

the market value of debt = 40,000 bonds x $1,150 = $46,000,000

total = $196,000,000

weight of equity = 0.7653

weight of debt = 0.2347

Re = 3.5% + [1.35 x (0.115 - 0.055)] = 0.035 + 0.081 = 0.116

cost of debt = ytm = {36.25 + [(1,000 - 1,150)/40]} /  [(1,000 + 1,150)/2] = (36.25 - 3.75) / 1,075 = 32.50 / 1,075 = 0.03023 x 2 = 0.0605

after tax cost of debt = 0.0605 x (1 - 40%) = 0.0363

WACC = (0.116 x 0.7653) + (0.0363 x 0.2347) = 0.09729 = 9.73%