Question

For the most recent fiscal year, book value of long-term debt at Schlumberger was $10,329 million. The market value of this long-term debt is approximately equal to its book value. Schlumberger’s share price currently is $47.2. The company has 1,000 million shares outstanding. Managers at Schlumberger estimate that the yield to maturity on any new bonds issued by the company will be 13.03%. Schlumberger’s marginal tax rate would be 35%. Schlumberger’s beta is 0.79. Suppose that the expected return on the market portfolio is 8% and the risk-free rate is 2%. Assume that the company will not change its capital structure. Also assume that the business risk of the projects under consideration is about the same as the business risk of Schlumberger as a whole. What would Schlumberger’s after-tax WACC be, given this information?

Answer 1

Answer:

WACC = [ ( Ke * Ve) +   Kd(1 - tax rate) Vd]/ ( Ve + Vd)

Ve =  $47.2 * 1,000 million  =  $47,200million

Vd =  $10,329million

Kd =  13.03%

Tax rate =  35%

ke =  2% + 0.79(8% - 2%)  =  6.74%

WACC =  [( 6.74%*47,200) +  13.03%(1 - 0.35) 10329]/ (47200+10329)

        =  (3181.28 +874.815)/ 57529

      = 0.070505  = 7.05%

Explanation:

Answer 2

Answer:

WACC 7.05052%

Explanation:

First, we solve for the cost of capital using CAPM:

$Ke= r_f + \beta (r_m-r_f)$

risk free = 0.02

market rate = 0.08

premium market = (market rate - risk free) 0.06

beta(non diversifiable risk) = 0.79

$Ke= 0.02 + 0.79 (0.06)$

Ke 0.06740

Then, we solve for the equity and debt weight using market value:

D  10,329

E  47,200

V  57,529

Equity weight = E/V =  0.8205

Debt Weight = D/V =  0.1795

Then, we can solve for the WACC:

$WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})$

$WACC = 0.0674(0.820455770133324) + 0.1303(1-0.35)(0.179544229866676)$

WACC 7.05052%