Question

A firm's balance sheet shows $900 million in shareholder's equity and $690 million in debt. The debt has an average yield to maturity of 6.7%. The firm also has $100 million in cash and short-term investments that is not required for business operations. The required return on the firm's equity is 14.0%, the current share price is $31.00, and it has 57 million shares outstanding. The corporate tax rate is 22%. What is this firm’s WACC?

8.0%

8.7%

9.8%

10.4%

11.8%

Answer 1

Answer: Option-(d): 10.4% Reason: Firm's weighted average cost of capital (WACC) = Weighted cost of equity Weighted after-tax cost of debt Required return on the firm's equity 14.0% $900 ($900+$690)] Weight of shareholder's equity 56.6% Weighted cost of equity 7.9% [14.0% x 56.6%] Debt's average yield to maturity 6.7% Firm's corporate tax rate 22.0% [$690 ($900+$690)] [6.7% x (1-22.0%) x 43.4%] Weight of shareholder's equity 43.4% Weighted after-tax cost of debt 2.3% Firm's weighted average cost of capital (WACC) 10.2% (7.9%+2.3% NOTE: WACC calculated is 10.2% which is so close to option-(d) 10.4%. The difference may be due to round-off in intermediate calculations.