Question

Beta of common stock = "1.7" Treasury bill rate = 4% Market risk premium = 7.0% Yield to maturity on long-term debt = 7% Book value of equity = $390 million Market value of equity = $780 million Long-term debt outstanding = $780 million Corporate tax rate = 21%

What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

10.72%

Step-by-step explanation:

Firstly, we need to calculate cost of equity using capital pricing model (CAPM):

Cost of equity = Risk-free rate + Beta x Market risk premium

= 4% + 1.7 x 7% = 15.9%

Note: Treasury bill rate is used as a proxy for risk-free rate in this case.

Then, we will calculate weighted average cost of capital (WACC) as below:

Weighted average cost of capital = Debt weight in capital structure x Pre-tax cost of debt x (1 - tax rate) + Equity weight in capital structure x Cost of equity

= [780/(780 + 780)] x 7% x (1 - 21%) + [780/(780 + 780)] x 15.9%

= 10.72%

Note: Yield to maturity on long-term debt is used as a proxy for pre-tax cost of debt in this case. Weights used in WACC calculation have to be based on market value.

So, the company WACC is 10.72%.