Final answer:
The company's WACC is calculated using the given financial data and the standard WACC formula. By computing the market values of equity and debt and factoring in the after-tax cost of debt, we arrive at a WACC of 9.19%. Thus (option e) is right answer.
Step-by-step explanation:
The formula to calculate the Weighted Average Cost of Capital (WACC) is:
WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)
Where:
E = Market value of equity
D = Market value of debt
V = E + D = Total market value of the company's financing (Equity + Debt)
Re = Cost of equity
Rd = Cost of debt
Tc = Corporate tax rate
Given the following:
Cost of equity (Re) = 11%
After-tax cost of debt (Rd) = 4.68%
Long-term debt (D) = $380,000
Equity from Balance Sheet (B) = $640,000
Market-to-book ratio (M/B) = 3.04 times
Tax rate (Tc) = 22%
To calculate E, which is the market value of equity, we multiply the book value of equity by the market-to-book ratio:
E = B * M/B = $640,000 * 3.04 = $1,945,600
As the bonds sell for 105.7% of par, the market value of the debt is:
D = $380,000 * 1.057 = $401,660
Now, calculate V:
V = E + D = $1,945,600 + $401,660 = $2,347,260
Using the WACC formula:
WACC = ($1,945,600 / $2,347,260) * 11% + ($401,660 / $2,347,260) * 4.68% * (1 - 0.22)
After calculating the above:
WACC = 9.19%
Thus (option e) is right answer.