Question

assume a firm has bonds outstanding that sell for 90% of par have a face value of $1000 Make $50 annual coupon payments and have 15 years left to maturity the firm stock has a beat her up to the TV bill rate is 1% and the return of the S and a P 500 index is 10% if the D/E ratio is 0.4 and the tax rate is 21% what is the WACC

Assume a firm has bonds outstanding that sell for 90% of par, have a face value of $1,000, make $50 annual coupon payments, and have 15 years left to maturity. The firm's stock has a beta of 2. The T-bill rate is 1% and the return of the S&P 500 index is 10%. If the D/E ratio is 0.4 and the tax rate is 21%, what is the WACC? 14.93% 10.23% 9.56% 7.45% 11.93%

Answer 1

Given:

Market price of Bond = 90% of Par value (also, known as face value) = $1000*90% = $900

Annual Coupon payment = $50

Years left to maturity= 15 years

Stock Beta= 2

T-Bill rate or Risk free rate (Rf)= 1%

S&P 500 index return or Market return (Rm)= 10%

Debt to Equity ration = 0.4

Tax Rate= 21%

Answer:

Weighted average cost of capital (WACC) = (Equity/ Total Volume)*(Cost of equity)+ (Debt/ Total Volume)*(Cost of debt)*(1-Tax rate)

Solving for Yield to Maturity (YTM) of the bond which will give us the cost of debt:

Here, the initial invetment will be $900, payment per year will be of $50 and last payment (at maturity)= Face value+Coupon payment= $1050

YEARS	YEAR 0	YEAR 1	YEAR 2	YEAR 3	YEAR 4	YEAR 5	YEAR 6	YEAR 7	YEAR 8	YEAR 9	YEAR 10	YEAR 11	YEAR 12	YEAR 13	YEAR 14	YEAR 15
PAYMENTS	-900.00	50.00	50.00	50.00	50.00	50.00	50.00	50.00	50.00	50.00	50.00	50.00	50.00	50.00	50.00	1,050.00
IRR	6.03%

IRR= YTM= 6.03%

Cost of equity= Rf + $\beta$ * (Rm-Rf) = 1% + 2* (10%-1%) = 1%+ 2(9%) = 19%

Debt to Equity ration = 0.4 i.e. Debt is 0.285 or 28.5% and Equity is 0.715 or 71.5%

WACC= (0.715) * (19%) + (0.285)* (6.03%) *(1-21%) = 0.1358 + 0.01358 = 0.1494 or 14.94%

Hence, WACC is 14.94% i.e. Option 1