Question

4) a) Ibrahim and his sons (Ibrahim & Sons) have been operating an excavation company in British Columbia for the last 15 years. The company has been successful in generating revenue and free cash flows (FCF). The company is planning to replace 5 excavators. The supplier will trade in old excavators and will deduct $100,000 from the total purchase price of new excavators. Each new excavator will cost $165,000. The corporate tax rate is 35%. The company beta (BA) is 2.45, risk-free return (Rt) is 1.45%, and the risk premium is 6%. Based on the risk, the bank will charge 7.50% on the commercial loans/chattel mortgages granted for excavators. The company will use 46% equity financing and 54% debt financing. Based on the above information, please calculate the WACC. Please show all the calculations by which you came up with the final answer. (3 Points)

Answer 1

Cost of equity(rj)=risk free rate(rf)+Beta(risk premium)

rj=1.45+2.45(6)

rj=16.15%

Cost of debt(before tax=7.5%

Cost of debt after tax(kd)=7.5*(1-tax rate)

kd=7.5*(1-..35)

kd=7.5*.65

kd=4.875

wacc=(rj*weight of equity)+(kd*weight of debt)

wacc=(16.15*.46)+(4.875*.54)

wacc=10.0615%