Question

ABC Inc. recently is doing the following financing: (1) The firm's non-callable bonds mature in 20 years, have an 7.00% Yield to Maturity. (2) The company’s tax rate is 35%. (3) The risk-free rate is 3.5%, the market return is 12%, and the stock’s beta is 1.10. (4) The target capital structure has a debt to equity ratio of 1.8. The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares. What is its WACC?

Answer 1

Type	Capital (market value)	% of total capital	× Required return after tax	WACC
Debt		64.29%	4.550%	2.93%
			=7%*(1-35%)
Common		35.71%	18.8000%	6.71%
		=1/(1+1.8)	=3.5%+1.8*(12%-3.5%)
	$                        -			9.64%

Cost of common stock is 18.8%

WACC is 9.64%