Question

Aaron's Rentals has 50,000 shares of common stock outstanding at a market price of $38 a share. The company has a beta of 1.2 and the market risk premium is 8%, with risk free rate of 3.5%. The outstanding bonds mature in 10 years, have a total face value of $800,000, a face value per bond of $1,000, and a market price of $987.60 each. The bonds pay 6% coupon. The tax rate is 30 percent. What is the firm's weighted average cost of capital?

Answer 1

Weighted average cost of capital is 10.52%

Step-1:Calculation of Weight of each component of capital
Market Value of debt	=	$ 8,00,000.00	/	$             1,000	*	$      987.60	=	$    7,90,080.00
Market Value of common stock	=	50,000	*	$                   38			=	$ 19,00,000.00
Total								$ 26,90,080.00
Weight of :
Debt		$       7,90,080	/	$     26,90,080	=	0.2937013
Common stock		$     19,00,000	/	$     26,90,080	=	0.7062987
Total						1.00000
Step-2:Calculation of cost of each component
Before tax cost of debt	=	=rate(nper,pmt,pv,fv)		Where,
	=	6.17%		nper	=	10
				pmt	=	$         60.00
				pv	=	$     -987.60
				fv	=	$   1,000.00
After tax cost of debt	=	6.17%	*(1-0.30)
	=	4.32%
Cost of common stock	=	Risk free rate + Beta*market risk premium
	=	3.5%+1.2*8%
	=	13.10%
Step-3:Calculation of WACC
		Weight	Cost
		a	b	c=a*b
Debt		0.293701303	4.32%	1.27%
Common stock		0.706298697	13.10%	9.25%
Total				10.52%
So,
WACC is	10.52%