Question

The Ashford Twins hired you as a consultant to estimate the company's WACC. You have obtained the following information. (1) The company's noncallable bonds mature in 20 years, have a coupon rate of 7.00% paid annually, a par value of $1,000, and a current market price of $850. (2) The company's tax rate is 28%. (3) The required rate of return on the company's common stock based on CAPM is 10.0%. (4) The target capital structure consists of 20% debt, with the remainder comprised of common equity. What is its WACC

Answer 1

9.24 %

Step-by-step explanation:

WACC = Cost of Equity x Weight of Equity + Cost of Debt x Weight of Debt

Remember to use the After tax cost of debt :

Cost of Debt r is

Pv = - $850

Fv = $1,000

n = 20

p/yr = 1

pmt = $1,000 x 7.00% = $70

r = ??

Using a financial calculator r is 8.60 %

thus,

After tax cost of debt = 8.60 % x (1 - 0.28)

= 6.192 %

therefore

WACC = 10.0% x 80 % + 6.192 % x 20 %

= 9.2384 or 9.24 %

The company's WACC is 9.24 %