A company has a capital structure of 30% debt and 70% equity. They are considering a...
A company has a capital structure of 30% debt and 70% equity. They are considering a project that requires an investment of $2.6 million. To finance this project, they plan to issue 10-year bonds with a coupon interest rate of 12%. Each of these bonds has a $1,000 face value and will be sold to net the company $980. If the current risk-free rate is 7% and the expected market return is 14.5%, what is the weighted cost of capital for the company? Assume WE have a beta of 1.20 and a marginal tax rate of 40%
Homework Answers
rE = Risk-free Rate + [beta * (Expected Market Return - Risk-free Rate)]
= 7% + [1.20 * (14.5% - 7%)]
= 7% + [1.20 * 7.5%]
= 7% + 9% = 16%
To find the rD, we need to put the following values in the financial calculator:
N = 10; PV = - 980; PMT = 12% * 1000 = 120; FV = 1000;
Press CPT, then I/Y, which gives us 12.36
So, rD = 12.36%
WACC = [wD * rD * (1 - t)] + [wE * rE]
= [0.30 * 12.36% * (1 - 0.40)] + [0.70 * 16%]
= 2.22% + 11.20% = 13.42%
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