Question

The market risk premium is 8 percent. · The beta on Fiscal Cliff's common stock is 2.3. · The company's retained earnings are sufficient so that they do not have to issue any new common stock to fund capital projects. · The company's tax rate is 40 percent. Given this information, what is Fiscal Cliff's WACC? A. 9.21% B. 12.58% C. 8.17% D. 7.63% E. 11.35%

Answer 1

A. 9.21%

Step-by-step explanation:

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

Cost of Equity calculation :

Cost of Equity = Interest from risk free security + beta x market premium

= 3.00 % + 2.3 x 8.00%

= 21.40 %

Cost of Debt calculation :

PV = - $700

FV = $1,000

N = 25

PMT = $1,000 x 8% = $80

P/YR = 1

I/YR = ???

The Bond`s yield will be the cost of debt. The cost of debt using a financial calculator i/yr is 11.76 %

But,

We always use the After tax cost of debt,

After tax cost of debt = interest x (1 - tax rate)

= 11.76 % x (1 - 0.40)

= 7.056 %

therefore,

WACC = 21.40 % x 15 % + 7.056 % x 85 %

= 9.2076 or 9.21 %