Question

Daves Inc. recently hired you as a consultant to estimate the company's WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,225.00. (2) The company's tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC? Do not round your intermediate calculations.
    a. 7.80%  
   b. 10.01%  
   c. 8.48%  
   d. 7.63%  
   e. 6.79%  

Answer 1

The WACC is computed as shown below:

= cost of debt x (1 - tax rate) x weight of debt + cost of common stock x weight of common stock

cost of debt is computed as follows:

Plug the below variables in the financial calculator as follows:

N = 20

PMT = 80

FV = 1,000

PV = - 1,225

Press CPT and then press I/Y. It will give I/Y equal to 6.033076774%

cost of equity is computed as follows:

= Risk free rate + beta x market risk premium

= 4.50% + 1.20 x 5.50%

= 11.10%

So, the WACC will be as follows:

= 6.033076774% x (1 - 0.40) x 0.35 + 0.1110 x (1 - 0.35)

= 8.48% Approximately

Feel free to ask in case of any query relating to this question