Question

Upton Umbrellas has a cost of equity of 11.6 percent, the YTM on the company's bonds is 6.2 percent, and the tax rate is 40 percent. The company's bonds sell for 103.2 percent of par. The debt has a book value of $408,000 and total assets have a book value of $952,000. If the market-to-book ratio is 2.74 times, what is the company's WACC?
a. 9.59%
b. 5.46%
c. 8.16%
d. 9.86%
e. 8.27%

Answer 1

Answer:

WACC = 9.86%

so correct option is d. 9.86%

Explanation:

given data

cost of equity = 11.6 percent

bonds = 6.2 percent

bonds sell = 103.2 percent

debt book value = $408,000

total assets book value= $952,000

market to book ratio = 2.74 times

to find out

what is the company's WACC

solution

we get here first Total book value of equity that is express as

Total book value of equity = Total assets book value - Total debt book value   .................1

Total book value of equity  = 952000 - 408000

Total book value of equity = $544000

and here market to book ratio  is

market to book ratio  = $\frac{market\ value}{book\ value}$

so market value of equity = (2.74 × 544000) = $1490560

and  

After tax cost of debt = 6.2 (1 - tax rate)

After tax cost of debt = 6.2 (1 - 0.4)

After tax cost of debt = 3.72%

and

Market value of Debt = 408000 × 103.2%  

Market value of Debt   = $421056

so

Total market value = $1490560 + $421056

Total market value is =$1911616

and  

WACC will be

WACC = Respective costs × Respective weights

WACC =  $\frac{1490560}{1911616}11.6 + 3.72\frac{421056}{1911616}$

WACC = 9.86%

so correct option is d. 9.86%