Question

What is ABC Inc.'s effective annual WACC given the following information?

ABC has no outstanding preferred stock
ABC does not pay any dividends
ABC has one issue of 10,000 bonds outstanding, each priced at $841.88. The bonds have a face value of $1000, pay semi-annual coupons at a rate of 9% APR compounded semi-annually, and mature in 15 years. The next coupon payment is 6-months from today.
ABC has 1,000,000 common stock shares outstanding, each priced at $16 per share. The stock has a CAPM LaTeX: \beta=\:β =1.1.
Risk-free return is 2% and the expected return of the market is 10%.
The firm faces a 28% tax rate.

Please do not use excel

Answer 1

What is ABC Inc's effective annual WACC given the following information? ABC has no outstanding preferred stock ABC does not pay any dividends ABC has one issue of 10,000 bonds outstanding, each priced at $841.88. The bonds have a face value of $1000, pay semi-annual coupons at a rate of 9% APR compounded semi-annually, and mature in 15 years. The next coupon payment is 6-months from today. ABC has 1,000,000 common stock shares outstanding, each priced at $16 per share. The stock has a CAPM LaTeX: \beta=\:ß =1.1. Risk-free return is 2% and the expected return of the market is 10%. The firm faces a 28% tax rate.

WACC = (weight of debt*after-tax cost of debt) + (weight of equity*cost of equity)

Calculation of weights:

Market value of debt = current price*number of bonds = 841.88*10,000 = 8,418,800

Market value of equity = current price*number of shares = 16*1,000,000 = 16,000,000

Total capital = market value of debt + market value of equity = 8,418,800 + 16,000,000 = 24,418,800

Weight of debt = market value of debt/total capital = 8,418,800/24,418,800 =0.34

Weight of equity = 1- weight of debt = 1-0.34 = 0.66

Calculation of costs:

Cost of debt:

PV (current price) = -841.88; FV (par value) = 1,000; PMT (semi-annual coupon) = annual coupon rate*par value/2 = 9%*1,000/2 = 45; N (number of coupons) = 15*2 = 30, solve for RATE.

Semi-annual yield = 5.60%, so annual YTM = 5.60%*2 = 11.20%

After-tax cost of debt = YTM*(1-Tax rate) = 11.20%*(1-28%) = 8.06%

Cost of equity (using CAPM) = risk-free rate + beta*(market return - risk-free rate) = 2% + 1.1*(10%-2%) = 10.80%

WACC = (0.34*8.06%) + (0.66*10.80%) = 9.86% (Answer)