Question

U nes weighted average cost UI Lupital! 17. (WACC) First Rate Ballroom, Inc, a national convention planner has 2,500 common shares and 1,000 bonds outstanding. Its securities have been performing very well in the marketplace. It enjoys a common stock price of $45 per share, up from $35 a year ago. It bonds have also performed well currently priced at $950 per bond, up from $899 a year ago. It stock has a beta coefficient of 2.5 and a market risk premium of 8.5%. The yield on 30-year Treasury Bonds is 5.5%. First Rate Ballroom's bonds are rather typical for the industry; having 30-year maturities, a 5% coupon rate, and a si face value. What is the WACC of First Rate Ballroom? First Rate is in the 35% marginal tax rate! 18. WACC) Second Rate Rallmom Inc a national . ..

Answer 1

Cost of Equity = Risk Free Rate + Beta*Market Risk Premium
= 5.5% + 2.5*8.5% = 26.75%

The cost of debt can be calculated by using the following excel formula:
=RATE(nper,pmt,pv,fv)
Here, Nper = 30 - 1 = 29, PMT = 1,000*5% = $50, PV = $950 and FV = $1,000

=RATE(29,50,-950,1000)
= 5.34%
Cost of debt before tax = 5.34%

After tax Cost of Debt = 5.34 * (1 - 0.35) = 3.47%

The market value weights are calculated as follows:

Total Value of Common Stock = Number of Common Share*Current Stock Price = 2,500*45 = $112,500

Total Value of Bonds = Number of Bonds*Current Bond Price = 1,000*950 = $950,000

Total Value of Firm = Total Value of Common Stock + Total Value of Bonds = 112,500 + 950,000 = $1,062,500

Now, we can determine weight of debt and equity as follows:

Weight of Equity = 112,500/1,062,500 = 0.1059

Weight of Debt = 950,000/1,062,500 = 0.8941

WACC can be calculated with the use of following formula:

WACC = (Weight of Debt*After-Tax Cost of Debt) + (Weight of Equity*Cost of Equity) = (0.1059 * 3.47%) + (0.8941 * 26.75%) = 5.93%

WACC = 5.93%