Question

Skolits Corp. has a cost of equity of 11 percent and an aftertax cost of debt of 4.68 percent. The company's balance sheet lists long-term debt of $380,000 and equity of $640,000. The company's bonds sell for 105.7 percent of par and the market-to-book ratio is 3.04 times. If the company's tax rate is 22 percent, what is the WACC? Multiple Choice 8.65% 10.54% 9.74% 9.92% 9.19%

Answer 1

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.