Question

8. The Paulson Company's year-end balance sheet is shown below. Its cost of common equity is 17%, its before-tax cost of debt is 8%, and its marginal tax rate is 25%. Assume that the firm's long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,160. The firm has 576 shares of common stock outstanding that sell for $4.00 per share.

Assets			Liabilities And Equity
Cash	$ 120		Accounts payable and accruals	$ 10
Accounts receivable	240		Short-term debt	60
Inventories	360		Long-term debt	1,100
Plant and equipment, net	2,160		Common equity	1,710
Total assets	$2,880		Total liabilities and equity	$2,880

Calculate Paulson's WACC using market-value weights. Do not round intermediate calculations. Round your answer to two decimal places.

  %

Answer 1

WACC using market-value weights

Formula for calculating WACC = Kd * Wd + Ke * Wd

Kd = after tax cost of debt

Wd = Weight of Debt

Ke = Cost of Equity

We = Weight of Equity

Calculations

Kd (After tax cost of debt)

Cost debt (before tax) = 8%

Tax rate = 25%

After tax cost of debt = cost of debt before tax * (1- tax rate)

                                      = 8%*(1-.25)

                                      =6%

Ke (Cost of Equity)

Cost of equity = 17% (given in the problem)

Weight of Equity and Debt

Wd (Weight of Debt) = (Total Debt ÷ Total Capital) x 100

                             = ($1,160 ÷ $3,464) x 100

                             =33.49%

We (Weight of Equity) = (Total Equity ÷ Total Capital) x 100

                             = ($2,304 ÷ $3,464) x 100

                             = 66.51%

Total Equity = Outstanding number of shares x Market selling price per share

                   = 576 shares x $4

                   =$2,304

Total Debt = $1,160 (given in problem)

Total Capital = Total Equity + Total Debt

                   =$2,304+$1,160

                   =$3,464

Final Answer

Formula for calculating WACC = Kd * Wd + Ke * Wd

Kd = after tax cost of debt = 6%

Wd = Weight of Debt = 33.49%

Ke = Cost of Equity = 17%

We = Weight of Equity = 66.51%

WACC = (6% x 33.49%) + (17% x 66.51%)

          = (.06 x .3349) + (.17 x .6651)

          = 13.32%