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Your company has three million shares of common stock outstanding with a current market price of...

Your company has three million shares of common stock outstanding with a current market price of $18. The market risk premium is 7.5%, and Treasury bills are yielding 6.25 percent. There are also 32,000 bonds outstanding with an 8 percent annual coupon, 18 years to maturity, and currently sell for $940. If the stock has a beta of 1.20 and the applicable tax rate is 40%, what is the WACC for your company?

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Answer #1

Debt:

Number of bonds outstanding = 32,000
Face Value = $1,000
Current Price = $940

Value of Debt = 32,000 * $940
Value of Debt = $30,080,000

Annual Coupon Rate = 8.00%
Annual Coupon = 8.00% * $1,000
Annual Coupon = $80

Time to Maturity = 18 years

Let Annual YTM be i%

$940 = $80 * PVIFA(i%, 18) + $1,000 * PVIF(i%, 18)

Using financial calculator:
N = 18
PV = -940
PMT = 80
FV = 1000

I = 8.67%

Annual YTM = 8.67%

Before-tax Cost of Debt = 8.67%
After-tax Cost of Debt = 8.67% * (1 - 0.40)
After-tax Cost of Debt = 5.202%

Equity:

Number of shares outstanding = 3,000,000
Current Price = $18

Value of Equity = 3,000,000 * $18
Value of Equity = $54,000,000

Cost of Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Equity = 6.25% + 1.20 * 7.50%
Cost of Equity = 15.25%

Value of Firm = Value of Debt + Value of Equity
Value of Firm = $30,080,000 + $54,000,000
Value of Firm = $84,080,000

Weight of Debt = $30,080,000 / $84,080,000
Weight of Debt = 0.3578

Weight of Equity = $54,000,000 / $84,080,000
Weight of Equity = 0.6422

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Equity *Cost of Equity
WACC = 0.3578 * 5.202% + 0.6422 * 15.25%
WACC = 11.65%

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