Question

The downtowner has 950,000 shares of common stock outstanding valued at $38 a share along with 40,000 bonds selling for $1,020 each. what weight should be given to the debt when the firm computes its weighted average cost of capital?

a. 46.67 percent
b. 55.05 percent
c. 53.06 percent
d. 51.79 percent
e. 48.27 percent

Answer 1

To determine the weight of the debt in the WACC, one must calculate the market values of both equity and debt, sum them for the total market value, and then find the proportion of debt. The correct calculation leads to 53.06% being the weight assigned to the debt.

Step-by-step explanation:

To calculate the weight of the debt in the firm's weighted average cost of capital (WACC), we need to determine the total market value of the debt and equity and then calculate the respective proportions. The market value of equity (MVE) is the number of shares of common stock multiplied by the price per share. The market value of debt (MVD) is the number of bonds multiplied by the price per bond.

First, calculate the market values:

MVE = 950,000 shares × $38/share = $36,100,000
MVD = 40,000 bonds × $1,020/bond = $40,800,000

Next, calculate the total market value of the firm (TMV) which is the sum of MVE and MVD:

TMV = MVE + MVD
TMV = $36,100,000 + $40,800,000
TMV = $76,900,000

Finally, calculate the weight of the debt (D/TMV), the proportion of TMV that is attributable to debt:

D/TMV = MVD / TMV
D/TMV = $40,800,000 / $76,900,000
D/TMV = 0.5306 or 53.06%

The final answer to give the weight for the debt when computing the WACC is option c. 53.06 percent.