Final answer:
To determine Upton Umbrellas' WACC, calculate the market values of equity and debt, find their proportions, adjust the cost of debt for taxes, and apply the WACC formula.
Step-by-step explanation:
To calculate the company's weighted average cost of capital (WACC), we need to determine the proportion of equity and debt in the company's capital structure and apply the cost of each. The market value of equity can be found by multiplying the book value of total assets by the market-to-book ratio, whereas the market value of debt is determined by its selling price as a percentage of par value. The after-tax cost of debt is adjusted for taxes because interest expenses are tax-deductible.
Here are the steps to calculate WACC:
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- Calculate the market value of equity:
$960,000 (book value of assets) × 2.98 (market-to-book ratio) = $2,860,800.
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- Calculate the market value of debt:
$432,000 (book value of debt) × 1.038 (selling price) = $448,416.
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- Calculate the proportion of equity (E/V) and debt (D/V):
E = $2,860,800; D = $448,416; V = E + D = $3,309,216.
E/V = $2,860,800 / $3,309,216; D/V = $448,416 / $3,309,216.
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- Adjust the cost of debt for taxes:
After-tax cost of debt = YTM × (1 - Tax Rate) = 5.9% × (1 - 0.25).
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- Apply the formula to calculate WACC:
WACC = (E/V × Cost of Equity) + (D/V × After-tax Cost of Debt).
Plugging in the numbers: WACC = (E/V × 12.4%) + (D/V × 5.9% × (1 - 0.25)).
Following these steps and performing the calculations will give us the company's WACC, which can be compared to the given multiple-choice options to determine the correct answer.