Question

A few years ago the firm issued $4,000,000 debt with a coupon rate of 4%; currently that debt is trading with a yield to maturity of 5.04% and a value of $3,500,000. The firm has 1,000,000 common shares outstanding at a value of $6/share. You look up the asset beta for firms in the same industry (SIC) code and determine that value is 1.15. The firm plans on keeping it's D/E ratio constant (at the current level) going forward and the tax rate is expected to be 35%. The beta of the firms debt is estimated as 0.30, the risk free rate is 3% and the market return is 9.8%.

Required:
Find the WACC for above firm.

Answer 1

WACC = 10.22%

Step-by-step explanation:

market value of debt = $3,500,00

Rd = 5.04%

current market value of equity = 1,000,000 x $6 = $6,000,000

Re = 3% + (1.15 x 9.8%) = 14.27%

weight of debt = $3,500 / $9,500 = 36.84%

weight of equity = $6,000 / $9,500 = 63.16%

WACC = (63.16% x 14.27%) + (36.84% x 5.04% x 65%) = 9.01% + 1.21% = 10.22%