Question

1. A Toys Company has 1.6 million shares in issue. The current market price is $35 per share. The company’s debt is publicly traded on the London Stock Exchange and the most recent quote for its price was at 96% of face value. The debt has a total face value of $ 8 million and the company’s credit risk premium is currently 2.9%. The risk-free rate is 3.4% and the equity market risk premium is 7%. The company’s beta is estimated at 1.1 and its corporate tax rate is 20%.

Required: Calculate the company’s WACC.

Answer 1

I will divide the answer into four parts:

1. Calculating the Market value of debt and equity and also calculating the percentage of each in firm's financing

2. Calculating Cost of equity

3. Calculating cost of debt

4. Calculating WACC

1. Calculating the Market value of debt and equity and also calculating the percentage of each in firm's financing

No. of shares Price of each share Total Equity 1,600,000.00 35 56,000,000.00 (B1*B2) Total Face Value of Debt Market value of debt Total Portion of equity Portion of debt 8,000,000.00 7,680,000.00 (96%of Face Value) 63,680,000.00 (B3+B6) 0.879396985 (B3/B7) 0.120603015 (1-08)

2. Calculating cost of equity

Cost of Equity = Risk-Free Rate of Return + Beta * (Market Rate of Return-Risk-Free Rate of Return) Risk free rate 3.40% Market risk premium 7% beta 1.1 Cost of equity 11.10% (B14+B16*(B15))

3. Calculating cost of debt

Cost of debt Tax rate Credit risk premuim Risk free rate Coupon rate Coupon rate*(1-tax rate) 20% 2.90% 3.40% 6.30% (B23+B24) Cost of debt 5.0400% (B25*(1-B22))

4. Calculating WACC

WACC=VE*Re+VD+Rd*(1-TC) Re = Cost of equity Rd = Cost of debt E = Market value of the firm's equity D = Market value of the firm's debt V=E+D = Total market value of the firm's financin gE/V = Percentage of financing that is equity D/V = Percentage of financing that is debt Tc = Corporate tax rate WACC 10.25% (B8*B18+B9*B27*(1-B22))