Question

4. Country Markets has an unlevered cost of capital of 11.45 percent, a tax rate of 35 percent, and expected earnings before interest and taxes of $18,700. The company has $11,000 in bonds outstanding that have an 8 percent coupon and pay interest annually. The bonds are selling at par value. What is the value of WACC? 9:45 AM

Answer 1

WACC = (Cost of equity X Equity / Value of firm) + (Cost of Debt X Debt / Value of firm) (1 – tax rate)

Let us calculate the value of unlevered firm:

V_{unlivered firm} = EBIT X (1 – Tax rate) / R_{unlevered cost of equity}

= $18,700 X (1 – 35%) / 11.45%

= $18,700 X 0.65 / 0.1145

= $106,157.205

Now calculate the value of levered firm:

V_{levered firm} = V_{unlevered firm} + (Debt x Tax rate)

= $106,157.205 +($11,000 x 35%)

= $106,157.205 + $3,850

= $110,007.205

Therefore the value of equity:

Value of equity = Value of firm – Value of debt

= $110,007.205 – $11,000

= $99,007.205

The cost of equity:

R_equity = R_{unlevered cost of equity} + [(Debt / Equity) X (R_{unlevered cost of equity} – R_debt)] X (1 – Tax rate)

= 11.45% + ($11,000 / $99,007.205) (11.45% – 8%} x (1 – 35%)

= 11.45% + ($11,000 / $99,007.205) X 0.0345 X 0.65

= 11.45% + 0.00249148

= 0.11699148 or 11.70%

WACC = (Cost of equity X Equity / Value of firm) + (Cost of Debt X Debt / Value of firm) (1 – tax rate)

= (11.70% X $99,007.205 / $110,007.205) + (8% X $11,000 / $110,007.205) (1 – 35%)

= (0.1170 X $99,007.205 / $110,007.205) + (0.08 X $11,000 / $110,007.205) (0.65)

= 0.1053 + 0.00799947 (0.65)

= 0.1053 + 0.00519965

= 0.11049965 or 11.05%

The value of WACC is 11.05%

Thank you, please give an upvote