Upton Umbrellas has a cost of equity of 11.5 percent, the YTM on the company's bonds...

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Upton Umbrellas has a cost of equity of 11.5 percent, the YTM on the companys bonds is 6.1 percent, and the tax rate is 39 p

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Answer 1

Answer #1

Market Value of Debt

Market Value of Debt = Book value of debt x 103.50%

= $405,000 x 103.10%

= $417,555

Market Value of Equity

Market Value of Equity = Book Value of Equity x Market-to-book ratio

= [Total book value of asset – Book value of Debt] x Market-to-book ratio

= [$951,000 - $405,000] x 2.71 Times

= $546,000 x 2.71 Times

= $1,479,660

Total Market Value

Total Market Value = Market value of debt + Market value of Equity

= $417,555 + $1,479,660

= $1,897,215

After Tax Cost of Debt

After Tax Cost of Debt = Yield to maturity of the Bond x (1 – Tax rate)

= 6.10% x (1 – 0.39)

= 6.10% x 0.61

= 3.72%

Cost of Equity = 11.50%

Weight of Debt = 0.2201 [$417,555 / $1,897,215]

Weight of Equity = 0.7799 [$1,479,660 / $1,897,215]

Weighted Average Cost of Capital (WACC)

Therefore, the Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]

= [3.72% x 0.2201] + [11.50% x 0.7799]

= 0.82% + 8.97%

= 9.79%

“Hence, the Company’s Weighted Average Cost of Capital (WACC) will be 9.79%”

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