Question

Use the following information about a firm to estimate the firm’s weighted average cost of capital.

• The firm has 4 million shares of common stock outstanding, trading at the price of $58 per share
• The firm currently has 175,000 shares of debt that are currently trading at $858 per share with a coupon payment paid semiannually at 5%, 7% yield to maturity, and 10 years to maturity with a par value of $1,000
• The risk-free rate is 1.1%
• The expected return of the market is 8.5%
• The stock has a beta of 1.20
• The firm has a marginal tax rate of 40%

What is the firm’s WACC?

**ENTER YOUR ANSWER AS A PERCENTAGE WITH ONE DECIMAL PLACE (e.g., 12.1) AND NOT AS A DECIMAL (e.g., 0.121). ROUND TO THE NEAREST TENTH OF A PERCENT.**

Answer 1

Market Value of Common Stock = No. of shares outstanding * Current Share Price

= 4,000,000 * $58 = $232,000,000

Market Value of Debt = No. of bonds outstanding * Current Bond Price

= 175,000 * $858 = $150,150,000

Total Market Value = Market Value of Common Stock + Market Value of Debt

= $232,000,000 + $150,150,000 = $382,150,000

According to the CAPM,

kE = Risk-free Rate + [Beta * (Expeted Market return - Risk-free rate)]

= 1.1% + [1.20 * (8.5% - 1.1%)]

= 1.1% + [1.20 * 7.4%] = 1.1% + 8.88% = 9.98%

WACC = [wD * kD * (1 - t)] + [wE * kE]

= [(150,150,000/382,150,000) * 7% * (1 - 0.40)] + [(232,000,000/382,150,000) * 9.98%]

= 1.65% + 6.06% = 7.71%