Question

Ray Stokes is raising capital for a new company called NO Balloons Inc. NO Balloons will manufacture and sell festive balloons. Because of the shortage of​ helium, the balloons will be filled with nitrous oxide instead. NO Balloons plans to finance the business with common equity and longminusterm debt. It plans to sell 12 million shares of common stock and​ 200,000 bonds. Each bond will have a coupon rate of​ 5% and will have a face value of​ $1,000.The common stock will be issued at a price of​ $19.5 a share. The bonds will sell for​ 89% of face value. The afterminustax cost of debt is​ 4% and the cost of equity of​ 9.275%. What is NO​ Balloons' WACC?

Answer 1

Answer:

NO Balloons' WACC = 7%

Explanation:

WACC = Weighted average cost of capital

The weighted average cost of capital (WACC) refers to calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC calculation.

Respective calculation of WACC:

Step 1: Calculate the value of equity:

Number of shares = 12 million

Share price = $19.5 per share

Value of equity = 12 million shares * 19.5/share = $234 million  (A)

Step 2: Calculate the value of debt:

Bonds = 200,000

Value of debt = 200,000 bonds * 1000 face value/bond * 89% sale price = 178 million  (B)

Step 3: Calculate the firm value:  

Total firm value (A+B) = 234 + 178 = 412 million

Step 4: Calculate the weight of equity:

Dividing the value of equity to total firm value:

Weight of equity = 234 / 412 = 0.5680

Step 5: Calculate the weight of debt:

Dividing the value of debt to total firm value

Weight of debt = 178 / 412 = 0.4320

Step 6: Calculation of WACC :

WACC = weight of equity * cost of equity + weight of debt * cost of debt = 0.5680 * 9.275% + 0.4320 * 4% = 7%