Question

[Ch 10] You are the CFO of a company, and you need to analyze a new product line. The company has 8% coupon-bonds outstanding with $1000 face value that trade at par. Their stock, which trades at $25 on the NASDAQ has a beta of 1.25 and just paid a dividend of $3.00 and the dividends are expected to grow at 5% annually, indefinitely. The company has a debt-to-equity ratio of 3 and pays taxes at the 35% annual tax rate. If the expected return on the market is 10% and treasury bills pay 4%, what is the weighted average cost of capital for FIN317 Corp?

Answer 1

Answer:

Check the following calculations

Explanation:

Bond trade at Par, thus,

Cost of Debt = Coupon rate = 8%

Tax rate = 35%

Post-tax cost of Debt (kd) = 0.08*(1-0.35) = 0.052

Beta of stock = 1.25

Market return = 10%

T-bills rate = 4%

Cost of Equity (ke) = 0.04*1.25*(0.1-0.04) = 0.115

Debt to equity ratio = 3

Weight of Debt (wd) = 3/4 = 0.75

Weight of equity (we) = 0.25

WACC= wd * kd+ we *ke

WACC =0.75* 0.052+0.25* 0.115

WACC =0.06775

WACC= 6.76%

Please note: In above solution, CAPM model used to determine the cost of equity because CAPM model gives minimum required return by equity investors.