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Alex787 [66]
3 years ago
13

Droz's Hiking Gear, Inc. has found that its common equity capital shares have a beta equal to 2.5 while the risk-free return is

9 percent and the expected return on the market is 14 percent. It has 7-year semiannual maturity bonds outstanding with a price of $787.22 that have a coupon rate of 8 percent. The firm is financed with $120,000,000 of common shares (market value) and $80,000,000 of debt. What is the after-tax weighted average cost of capital for Droz's, if it is subject to a 30 percent marginal tax rate
Business
1 answer:
11111nata11111 [884]3 years ago
7 0

Answer:

see explanation

Explanation:

Weighted Average Cost of Capital (WACC) is the cost of a firm from permanent sources of capital pooled together.

WACC = Cost of equity x Weight of equity + Cost of Debt x Weight of Debt + Cost of Preference Stock x Weight of Preference Stock

where,

Cost of equity = Return on Risk free rate + Beta x Risk Premium

                        = 9.00 % + 2.5  x (14.00 % - 9.00%)

                        = 21.50 %

Cost of debt :

<em>similar</em>

N = 7 x 2 = 14

p/yr = 2

pmt = ($787.22 x 8%) ÷ 2 =

fv = $787.22 x number of bonds

pv = $80,000,000

<u>Always use the after tax cost of debt :</u>

after tax cost of debt = interest x ( 1 - tax rate)

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Answer:

$1,388,200

Explanation:

The total stock holders equity as at the end of the year shall be determined as follows:

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Balance of Jan 1       $597,000           $690,000                $1,287,000

Net income for year                             $96,000                  $96,000

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Balance at year end  $617,000           $771,200                  $1,388,200

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I have included a simple graph to illustrate.

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