Question

The wilson bat company has, at market value, $300,000 in bonds and $700,000 in stock outstanding. the coupon rate on the debt, which is currently selling at par, is 7%. the company's current stock price is $20, with an equity beta of 1.8 and an expected dividend next year of $1.40 which is expected to grow at 6% indefinitely. the company faces a corporate tax rate of 25%. wilson is considering purchasing harrison balls, inc. as part of its acquisition research, wilson has determined that the average beta for ball manufacturers is 1.2. the current risk-free rate is 4%, and the current return on the s&p 500 is 8%. calculate wilson's wacc. the cfo directs that in calculating this wacc you are to calculate the equity return using the capm.

Answer 1

Debt = 300,000

Equity = 700,00

Weight of debt = 0.3 and weight of equity =0.7

Since the bonds are selling at par, YTM = coupon rate = 7%. The after tax cost of debt = 7%*(1-0.25) = 5.25%

Cost of equity as per CAPM = rf +beta*(Rm-rf) = 4% + 1.2*(8-4) = 8.8%

WACC = 0.3*5.25 + 0.7*8.8 = 7.735%