Final answer:
The company's WACC is 10.59%.
Step-by-step explanation:
To calculate the Weighted Average Cost of Capital (WACC) for the given company, we need to consider the cost of equity and the cost of debt.
1. Cost of Equity:
The cost of equity is calculated using the Capital Asset Pricing Model (CAPM) formula:
Cost of Equity = Risk-Free Rate + Beta × Market Risk Premium
Given:
Risk-Free Rate: 3%
Beta: 1.5
Expected Market Risk Premium: 6%
Calculating:
Cost of Equity = 3% + 1.5 × 6% = 12%
2. Cost of Debt:
The cost of debt is the pre-tax yield on current debt:
Given:
Market Value of Debt: $500 million
Average Yield on Current Debt: 4%
Tax Rate: 18%
Calculating:
Tax Adjusted Cost of Debt = Average Yield on Current Debt × (1 - Tax Rate) = 4% × (1 - 0.18) = 3.28%
3. Weighted Average Cost of Capital (WACC):
The WACC is calculated by weighting the cost of equity and the cost of debt with their respective proportions in the company's capital structure:
Given:
Market Value of Equity: Market Price of Each Share × Number of Shares Outstanding = $20 × 75 million = $1.5 billion
Market Value of Debt: $500 million
Calculating:
WACC = (Market Value of Equity / Total Market Value) × Cost of Equity + (Market Value of Debt / Total Market Value) × Tax Adjusted Cost of Debt = ($1.5 billion / ($1.5 billion + $500 million)) × 12% + ($500 million / ($1.5 billion + $500 million)) × 3.28% = 10.59%