Question

ABC Corporation has 2.8 million shares of stock outstanding. The stock currently sells for $50 per share. The firm’s debt is publically traded and was recently quoted at 95 percent of its face value. It has a total face value of $10 million, and it is currently priced to yield 12 percent. The risk-free rate is 5 percent, and the market risk premium is 7 percent. You’ve estimated that ABC has a beta of 1.25. If the corporate tax rate is 35 percent, what is the WACC of ABC Corporation?

Multiple Choice

9.38%

10.88%

11.38%

12.88%

13.38%

Answer 1

13.38%

Step-by-step explanation:

The formula to compute WACC is shown below:

= Weightage of debt × cost of debt × ( 1- tax rate) + (Weightage of common stock) × (cost of common stock)

where,

Market value of equity = 2,800,000 × $50 = $140,000,000

Market value of debt = 10,000,000 × 95% = $9,500,000

Weighted of debt = Debt ÷ total firm

The total firm includes debt, preferred stock, and the equity which equals to

= $140,000,000 + $9,500,000

= $149,500,000

So, Weighted of debt = ($9.5 million ÷ $149.50 million) = 0.0635

And, the weighted of common stock = (Common stock ÷ total firm)

= $140 million ÷ $149.50 million

= 0.9364

And, the cost of equity = risk free rate of return + Beta × market risk premium

= 5% + 1.25 × 7%

= 5% + 8.75%

= 13.75%

Now put these values to the above formula

So, the value would equal to

= ( 0.0635 × 12%) × ( 1 - 35%) + (0.9364 × 13.75%)

= 0.4953 + 12.88%

= 13.372%