ABC Trucking's balance sheet shows a total of noncallable $38
million long-term debt with a coupon rate of 5.60% and a yield to
maturity of 8.80%. This debt currently has a market value of $55
million. The balance sheet also shows that the company has 12
million shares of common stock, and the book value of the common
equity is $216.20 million. The current stock price is $20.10 per
share; stockholders' required return, rs, is 14.15%; and the firm's
tax rate is 37.00%. The CFO thinks the WACC should be based on
market value weights, but the president thinks book weights are
more appropriate. What is the difference between the WACCs using
market value and the book value?
Work with at least 4 decimals and round your final answer to two
decimal places. For example, if your answer is $345.6671 round as
345.67 and if your answer is .05718 or 5.7182% round as 5.72.
Market value WACC is more better than compared to Book value WACC. | |||||||
Below is the computation of WACC | |||||||
Market value | |||||||
Source | Value | Weight | Cost of capital | cost * Weight | |||
Equity | 241.2 | =20.1*12mil | 81.43% | 14.15% | 11.52% | ||
Debt | 55 | =20.1*12mil | 18.57% | 5.54% | 1.03% | ||
296.2 | 12.55% | ||||||
Post tax cost of debt = 8.8%*(1-37%) | 5.54% | ||||||
Therefore market value WACC = | 12.55% | ||||||
Book value | |||||||
Source | Value | Weight | Cost of capital | cost * Weight | |||
Equity | 216.2 | 85.05% | 14.15% | 12.03% | |||
Debt | 38 | 14.95% | 5.54% | 0.83% | |||
254.2 | 12.86% | ||||||
Therefore market value WACC = | 12.86% | ||||||
Difference in WACC = | -0.31% |
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