Question

Company A currently has a stock price $20/per share, with outstanding shares 2 Mil shares. It also has outstanding debt of 20 Mil. Tax rate is 30%. Its annual bond with 10 year maturity date has a price now $886, par value $1000 and coupon rate is 7%. It has a beta of risk 1.2, risk free rate 4% and market index return 9%.

Please answer following parts with above information
Part1) what is the cost of debt before tax?
Part 2) what is the after tax cost of debt?
Part 3) how much is total equity?
Part 4) what is the cost of equity?
Part5) what is the weight of debt?
Part 6) what is the WACC?

Answer 1

Answer and Explanation:

The computation is shown below:

1, The cost of debt before tax is

Given that

NPER = 10%

PMT - $1,000 × 7% = $70

PV = $886

FV = $1,000

The formula is given below:

= RATE(NPER;PMT;-PV;FV;TYPE)

After applying the above formula, the before tax cost of debt is 8.76%

2. The after tax cost of debt is

= 8.76% × (1 - 0.30)

= 6.13%

3. The total equity is

= $20 per share × 2million shares

= $40 million

4. The cost of equity is

= Risk free rate of return + Beta × (Market rate of return - risk free rate)

= 4% + 1.2 × (9% - 4%)

= 10%

5. The weight of debt is

= ($886 × 20 ÷ $1,000 ) ÷ (886 × 20 ÷ $1,000 + $40)

= 30.70%

6. The WACC is

= Weight of debt × after tax cost of debt + weight of equity × cost of equity

= 30.70% × 6.13% + (1 - 0.3070) × 10%

= 8.81%